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0001019687-03-000569.txt : 20030326
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20030326155453
ACCESSION NUMBER: 0001019687-03-000569
CONFORMED SUBMISSION TYPE: 10-K
PUBLIC DOCUMENT COUNT: 2
CONFORMED PERIOD OF REPORT: 20021231
FILED AS OF DATE: 20030326
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: CONSUMER PORTFOLIO SERVICES INC
CENTRAL INDEX KEY: 0000889609
STANDARD INDUSTRIAL CLASSIFICATION: FINANCE SERVICES [6199]
IRS NUMBER: 330459135
STATE OF INCORPORATION: CA
FISCAL YEAR END: 1231
FILING VALUES:
FORM TYPE: 10-K
SEC ACT: 1934 Act
SEC FILE NUMBER: 001-14116
FILM NUMBER: 03618405
BUSINESS ADDRESS:
STREET 1: 16355 LAGUNA CANYON
CITY: IRVINE
STATE: CA
ZIP: 92618
BUSINESS PHONE: 9497536800
10-K
1
cps_10k-123102.txt
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER: 1-14116
CONSUMER PORTFOLIO SERVICES, INC.
(Exact name of registrant as specified in its charter)
CALIFORNIA 33-0459135
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
16355 LAGUNA CANYON ROAD, IRVINE, CALIFORNIA 92618
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 753-6800
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of each class: Name of each exchange on which
registered:
10.50% Participating Equity Notes due 2004 New York Stock Exchange
Rising Interest Subordinated Redeemable
Securities due 2006 New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, No Par Value
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [ x ]
The aggregate market value on March 25, 2003 (based on the $1.62 per share
closing price on the Nasdaq Stock Market on that date) of the voting stock
beneficially held by non-affiliates of the registrant was approximately
$20,563,000. The number of shares of the registrant's Common Stock outstanding
on March 25, 2003, was 20,239,176.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's proxy statement for its 2003 annual meeting of shareholders is
incorporated by reference into Part III of this report.
================================================================================
PART I
ITEM 1. BUSINESS
GENERAL
Consumer Portfolio Services, Inc. ("CPS," and together with its subsidiaries,
the "Company") is a consumer finance company specializing in the business of
purchasing, selling and servicing retail automobile installment purchase
contracts ("Contracts") originated by licensed motor vehicle dealers ("Dealers")
in the sale of new and used automobiles, light trucks and passenger vans.
Through its purchases, the Company provides indirect financing to Dealer
customers with limited credit histories, low incomes or past credit problems
("Sub-Prime Customers"). The Company serves as an alternative source of
financing for Dealers, allowing sales to customers who otherwise might not be
able to obtain financing. The Company does not lend money directly to consumers.
Rather, it purchases installment Contracts from Dealers.
CPS was incorporated and began its operations in 1991. From inception through
December 31, 2002, the Company has purchased approximately $4.6 billion of
Contracts. The Company also obtained in March 2002, an additional $381.8 million
of Contracts when the Company acquired MFN Financial Corporation and its
subsidiaries in a merger (the "MFN Merger"). MFN Financial Corporation and its
subsidiaries (collectively, the "MFN Companies") were engaged in business
similar to that of the Company: buying Contracts from Dealers, pooling and
selling those Contracts in securitization transactions, and servicing those
Contracts.
The Company makes the decision to purchase Contracts exclusively from its
headquarters location. Prior to the MFN Merger, the Company had primarily
serviced Contracts from two regional centers, one in its California
headquarters, and the other in Virginia, as well as a small satellite office in
Dallas, Texas. Following the MFN Merger the Company also services Contracts
obtained in the MFN Merger from multiple other locations acquired in that
transaction. As of December 31, 2002, the Company had an outstanding servicing
portfolio, net of unearned income on pre-computed Contracts, of approximately
$595.2 million, including the remaining outstanding balance of Contracts
acquired in the MFN Merger.
CREDIT RISK RETAINED
The Company purchases Contracts with the intention of reselling them in
securitizations. In a securitization, the Company sells Contracts to a special
purpose subsidiary, which funds the purchase by sale of asset-backed,
interest-bearing securities. At the closing of each securitization, the Company
removes the sold Contracts from its Consolidated Balance Sheet. The Company
remains responsible for collecting payments due under the Contracts, and retains
a residual interest in the sold Contracts. The residual interest represents the
discounted value of what the Company expects will be the excess of future
collections on the Contracts over principal and interest due on the asset-backed
securities. That residual interest appears on the Company's Consolidated Balance
Sheet as "residual interest in securitizations," and its value is dependent on
estimates of the future performance of the sold Contracts. Further, the special
purpose subsidiary may be prohibited from releasing the excess cash to the
Company if the credit performance of the sold Contracts falls short of
pre-determined standards. Such releases represent a material portion of the cash
that the Company uses to fund its operations. An unexpected deterioration in the
performance of sold Contracts could therefore have a material adverse effect on
both the Company's liquidity and its results of operations. See "--
Securitization and Sale of Contracts," "-- The Servicing Agreements," and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
THE MARKET WE SERVE
The Company's automobile financing programs are designed to serve customers who
generally would not qualify for automobile financing from traditional sources,
such as commercial banks, credit unions and the captive finance companies
affiliated with major automobile manufacturers. Such customers generally have
limited credit histories, low incomes or past credit problems, and are therefore
often unable to obtain credit from traditional sources of automobile financing.
(The terms "prime" and "sub-prime" reflect the Company's categorization of
customers and bear no relationship to the prime rate of interest or persons who
are able to borrow at that rate.) Because the Company serves customers who are
unable to meet the credit standards imposed by most traditional automobile
financing sources, the Company generally receives interest at rates higher than
those charged by traditional automobile financing sources. The Company also
sustains a higher level of credit losses than traditional automobile financing
sources since the Company provides financing in a relatively high risk market.
MARKETING
The Company directs its marketing efforts to Dealers, rather than to consumers.
As of December 31, 2002, the Company was a party to its standard form dealer
agreements ("Dealer Agreements") with over 3,000 Dealers. Approximately 95% of
these Dealers are franchised new car dealers that sell both new and used cars
and the remainder are independent used car dealers. For the year ended December
31, 2002, approximately 88% of the Contracts purchased by the Company consisted
of financing for used cars and the remaining 12% for new cars, as compared to
87% used and 13% new in the year ended December 31, 2001.
The Company establishes relationships with Dealers through Company
representatives who contact a prospective Dealer to explain the Company's
Contract purchase programs, and who thereafter provide Dealer training and
support services. As of December 31, 2002, the Company had 40 representatives,
39 of whom were employees and one of whom was independent. The representatives
are contractually obligated to represent the Company's financing program
exclusively. The Company's representatives present the Dealer with a marketing
package, which includes the Company's promotional material containing the terms
offered by the Company for the purchase of Contracts, a copy of the Company's
standard-form Dealer Agreement, examples of monthly reports, and required
documentation relating to Contracts. Marketing representatives have no authority
relating to the decision to purchase Contracts from Dealers.
Most of the Dealers under contract with CPS regularly submit Contracts to the
Company for purchase, although they are under no obligation to submit any
Contracts to the Company, nor is the Company obligated to purchase any
Contracts. During the year ended December 31, 2002, no Dealer accounted for more
than 1% of the total number of Contracts purchased by the Company. The following
table sets forth the geographical sources of the Contracts purchased by the
Company (based on the addresses of the customers as stated on the Company's
records) during the years ended December 31, 2002 and 2001. Contracts purchased
by the MFN Companies are not included in the table as MFN Contract purchases
were terminated shortly after the MFN Merger. All Contracts are acquired from
Dealers located within the United States.
2

ORIGINATION OF CONTRACTS
DEALER ORIGINATION
When a retail automobile buyer elects to obtain financing from a Dealer, the
Dealer takes a credit application to submit to its financing sources. Typically,
a Dealer will submit the buyer's application to more than one financing source
for review. The Company believes the Dealer's decision to finance the automobile
purchase with the Company, rather than other financing sources, is based
primarily on the monthly payment that will be offered to the automobile buyer,
the purchase price offered for the Contract, the timeliness, consistency and
predictability of response, the cash resources of the financing source, and any
conditions to purchase.
Upon receipt of information from a Dealer, the Company's administrative
personnel order a credit report to document the buyer's credit history. If, upon
review by a Company credit analyst, it is determined that the Contract meets the
Company's underwriting criteria, or would meet such criteria with modification,
the Company requests and reviews further information and supporting
documentation and, ultimately, decides whether to purchase the Contract. When
presented with an application, the Company attempts to notify the Dealer within
two hours as to whether it would purchase the related Contract.
The actual agreement for purchase of the vehicle ("Contract") is prepared by the
Dealer. The Dealer also arranges for recording the Company's lien on the
vehicle. After the appropriate documents are signed by the Dealer and the
customer, the Dealer sells the Contract to the Company. During 2001 and the
first quarter of 2002 the Company immediately sold most of the Contracts that it
purchased, and held the remainder for its own account. See "--Flow Purchase
Program." The customer thereafter receives monthly billing statements.
The Company purchases Contracts from Dealers at a price generally equal to the
total amount financed under the Contracts, adjusted for an acquisition fee,
which varies based on the perceived credit risk and, in some cases, the interest
rate on the Contract. For the years ended December 31, 2002, 2001 and 2000, the
average fee charged per Contract purchased was $313, $355 and $469,
3
respectively, or 2.2%, 2.4% and 3.2%, respectively, of the amount financed. The
Company also purchases certain Contracts for a premium over the amount financed.
The Company is willing to pay a premium when it estimates the credit risk to be
low, compared to that of other Contracts that it purchases. During 2002, 2001
and 2000, respectively, the Company purchased 9,971, 9,962 and 2,104 of these
Contracts, representing approximately 30.9%, 21.7% and 5.1% of all Contracts
purchased. The average premium paid to Dealers on these Contracts was $435, $172
and $595, respectively.
The Company attempts to control misrepresentation regarding the customer's
credit worthiness by carefully screening the Contracts it purchases, by
establishing and maintaining professional business relationships with Dealers,
and by including certain representations and warranties by the Dealer in the
Dealer Agreement. Pursuant to the Dealer Agreement, the Company may require the
Dealer to repurchase any Contract in the event that the Dealer breaches its
representations or warranties. There can be no assurance, however, that any
Dealer will have the willingness or the financial resources to satisfy its
repurchase obligations to the Company.
OBJECTIVE CONTRACT PURCHASE CRITERIA
To be eligible for purchase by the Company, a Contract must have been originated
by a Dealer that has entered into a Dealer Agreement to sell Contracts to the
Company. The Contracts must be secured by a first priority lien on a new or used
automobile, light truck or passenger van and must meet the Company's
underwriting criteria. In addition, each Contract requires the customer to
maintain physical damage insurance covering the financed vehicle and naming the
Company as a loss payee. The Company or any purchaser of the Contract from the
Company may, nonetheless, suffer a loss upon theft or physical damage of any
financed vehicle if the customer fails to maintain insurance as required by the
Contract and is unable to pay for repairs to or replacement of the vehicle or is
otherwise unable to fulfill his or her obligations under the Contract.
The Company believes that its objective underwriting criteria enable it to
evaluate effectively the creditworthiness of Sub-Prime Customers and the
adequacy of the financed vehicle as security for a Contract. These criteria
include standards for price, term, amount of down payment, installment payment
and interest rate; mileage, age and type of vehicle; principal amount of the
Contract in relation to the value of the vehicle; customer income level,
employment and residence stability, credit history and debt service ability; and
other factors. Specifically, the Company's guidelines limit the maximum
principal amount of a purchased Contract to 115% of wholesale book value in the
case of used vehicles or to 115% of the manufacturer's invoice in the case of
new vehicles, plus, in each case, sales tax, licensing and, when the customer
purchases such additional items, a service contract or a credit life or
disability policy. The Company does not finance vehicles that are more than
seven model years old or have in excess of 85,000 miles. Under most CPS
programs, the maximum term of a purchased Contract is 72 months; a shorter
maximum term may be applied based on the year and mileage of the vehicle, and
Contracts with the maximum term of 72 months may be purchased if the customer is
among the more creditworthy of CPS's obligors and the vehicle is not more than
two model years old and has less than 25,000 miles. Contract purchase criteria
are subject to change from time to time as circumstances may warrant. Upon
receiving this information with the customer's application, the Company's
underwriters verify the customer's employment, residency, insurance and credit
information provided by the customer by contacting various parties noted on the
customer's application, credit information bureaus and other sources. In
addition, prior to purchasing a Contract, CPS contacts each customer by
telephone to confirm that the Customer understands and agrees to the terms of
the related Contract.
CREDIT SCORING. The Company uses a proprietary scoring model to assign to each
Contract a "credit score" at the time the application is received from the
Dealer and the customer's credit information is retrieved from the credit
4
reporting agencies. The credit score is based on a variety of parameters, such
as the customer's employment and residence stability, the amount of the down
payment, and the age and mileage of the vehicle. The Company has developed the
credit score as a means of improving its allocation of credit evaluation
resources, and managing the risk inherent in the sub-prime market.
CHARACTERISTICS OF CONTRACTS. All of the Contracts purchased by the Company are
fully amortizing and provide for level payments over the term of the Contract.
The average original principal amount financed under Contracts purchased in the
year ended December 31, 2002 was approximately $14,362, with an average original
term of approximately 60.2 months and an average down payment amount of 12.5%.
Based on information contained in customer applications, for this twelve-month
period, the retail purchase price of the related automobiles averaged $14,585
(which excludes tax and license fees, and any additional costs such as a
maintenance contract), the average age of the vehicle at the time the Contract
was purchased was 2 years, and the Company's customers averaged approximately 37
years of age, with approximately $36,036 in average annual household income and
an average of 4.8 years' history with his or her current employer.
All Contracts may be prepaid at any time without penalty. In the event a
customer elects to prepay a Contract in full, the payoff amount is calculated by
deducting the unearned income from the Contract balance, in the case of a
pre-computed Contract, or by adding accrued interest to the Contract balance, in
the case of a simple interest Contract.
Each Contract purchased by the Company prohibits the sale or transfer of the
financed vehicle without the Company's consent and allows for the acceleration
of the maturity of a Contract upon a sale or transfer without such consent. The
Company generally does not consent to a sale or transfer of a financed vehicle
unless the related Contract is prepaid in full.
DEALER COMPLIANCE. The Dealer Agreement and related assignment contain
representations and warranties by the Dealer that an application for state
registration of each financed vehicle, naming the Company as secured party with
respect to the vehicle, was effected at the time of sale of the related Contract
to the Company, and that all necessary steps have been taken to obtain a
perfected first priority security interest in each financed vehicle in favor of
the Company under the laws of the state in which the financed vehicle is
registered. If a Dealer or the Company, because of clerical error or otherwise,
has failed to take such action in a timely manner, or to maintain such interest
with respect to a financed vehicle, neither the Company nor any purchaser of the
related Contract from the Company would have a perfected security interest in
the financed vehicle and its security interest may be subordinate to the
interest of, among others, subsequent purchasers of the financed vehicle,
holders of perfected security interests and a trustee in bankruptcy of the
customer. The security interest of the Company or the purchaser of a Contract
may also be subordinate to the interests of third parties if the interest is not
perfected due to administrative error by state recording officials. Moreover,
fraud or forgery could render a Contract unenforceable. In such events, the
Company could suffer a loss with respect to the related Contract. In the event
the Company suffers such a loss, it will generally have recourse against the
Dealer from which it purchased the Contract. This recourse will be unsecured,
and there can be no assurance that any particular Dealer will satisfy any such
repurchase obligations to the Company.
SERVICING OF CONTRACTS
GENERAL. The Company's servicing activities consist of collecting, accounting
for and posting of all payments received; responding to customer inquiries;
taking all necessary action to maintain the security interest granted in the
financed vehicle or other collateral; investigating delinquencies; communicating
with the customer to obtain timely payments; repossessing and liquidating the
collateral when necessary; and generally monitoring each Contract and the
related collateral.
5
COLLECTION PROCEDURES. The Company believes that its ability to monitor
performance and collect payments owed from Sub-Prime Customers is primarily a
function of its collection approach and support systems. The Company believes
that if payment problems are identified early and the Company's collection staff
works closely with customers to address these problems, it is possible to
correct many of them before they deteriorate further. To this end, the Company
utilizes pro-active collection procedures, which include making early and
frequent contact with delinquent customers; educating customers as to the
importance of maintaining good credit; and employing a consultative and customer
service approach to assist the customer in meeting his or her obligations, which
includes attempting to identify the underlying causes of delinquency and cure
them whenever possible. In support of its collection activities, the Company
maintains a computerized collection system specifically designed to service
automobile installment sale contracts with Sub-Prime Customers and similar
consumer obligations.
With the aid of its high-penetration automatic dialer, as well as manual efforts
made by collection staff, the Company typically attempts to make telephonic
contact with delinquent customers on the sixth day after their monthly payment
due date. Using coded instructions from a collection supervisor, the automatic
dialer will attempt to contact customers based on their physical location, state
of delinquency, size of balance or other parameters. If the automatic dialer
obtains a "no-answer" or a busy signal, it records the attempt on the customer's
record and moves on to the next call. If a live voice answers the automatic
dialer's call, the call is transferred to a waiting collector at the same time
that the customer's pertinent information is simultaneously displayed on the
collector's workstation. The collector then inquires of the customer the reason
for the delinquency and when the Company can expect to receive the payment. The
collector will attempt to get the customer to make a promise for the delinquent
payment for a time generally not to exceed one week from the date of the call.
If the customer makes such a promise, the account is routed to a promise queue
and is not contacted until the outcome of the promise is known. If the payment
is made by the promise date and the account is no longer delinquent, the account
is routed out of the collection system. If the payment is not made, or if the
payment is made, but the account remains delinquent, the account is returned to
the queue for subsequent contacts.
If a customer fails to make or keep promises for payments, or if the customer is
uncooperative or attempts to evade contact or hide the vehicle, a supervisor
will review the collection activity relating to the account to determine if
repossession of the vehicle is warranted. Generally, such a decision will occur
between the 45th and 90th day past the customer's payment due date, but could
occur sooner or later, depending on the specific circumstances.
If CPS elects to repossess the vehicle, it assigns the task to an independent
local repossession service. Such services are licensed and/or bonded as required
by law. When the vehicle is recovered, the repossessor delivers it to a
wholesale auto auction, where it is kept until sold. The Uniform Commercial Code
("UCC") and other state laws regulate repossession sales by requiring that the
secured party provide the customer with reasonable notice of the date, time and
place of any public sale of the collateral, the date after which any private
sale of the collateral may be held and of the customer's right to redeem the
financed vehicle prior to any such sale and by providing that any such sale be
conducted in a commercially reasonable manner. Financed vehicles that have been
repossessed are generally resold by the Company through unaffiliated automobile
auctions, which are attended principally by car dealers. Net liquidation
proceeds are applied to the customer's outstanding obligation under the
Contract. Such proceeds usually are insufficient to pay the customer's
obligation in full, resulting in a deficiency.
Under the UCC and other laws applicable in most states, a creditor is entitled
to obtain a judgment against a customer for such a deficiency. However, some
states impose prohibitions or limitations on deficiency judgments. When
obtained, deficiency judgments are entered against defaulting individuals who
may have little capital or income. Therefore, in many cases, it may not be
useful to seek a deficiency judgment against a customer or, if one is obtained,
it may be settled at a significant discount.
6
CREDIT EXPERIENCE
The Company's financial results are dependent on the performance of the
Contracts in which it retains an ownership interest. The tables below document
the delinquency, repossession and net credit loss experience of all Contracts
that the Company was servicing as of the respective dates shown. Credit
experience for CPS and MFN (since the Merger Date) is shown on both a combined
and individual basis in the tables below.

7
MFN
DECEMBER 31, 2002
-----------------
NUMBER OF
CONTRACTS AMOUNT
--------- ------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1)............... 43,696 $221,674
Period of delinquency (2)
31-60 days ................................. 1,924 7,650
61-90 days ................................. 898 2,976
91+ days ................................... 543 1,914
--------- ---------
Total delinquencies (2)..................... 3,365 12,540
Amount in repossession (3).................. 748 4,530
--------- ---------
Total delinquencies and amount in
repossession (2)............................ 4,113 $ 17,070
========= =========
Delinquencies as a percentage of
gross servicing portfolio .................. 7.7% 5.7%
Total delinquencies and amount in
repossession as a percentage of
gross servicing portfolio .................. 9.4% 7.7%
- ------------
(1) All amounts and percentages are based on the amount remaining to be repaid
on each Contract, including, for pre-computed Contracts, any unearned interest.
The information in the table represents the gross principal amount of all
Contracts purchased by the Company on an other than flow basis, including
Contracts subsequently sold by the Company in securitization transactions that
it continues to service.
(2) The Company considers a Contract delinquent when an obligor fails to make at
least 90% of a contractually due payment by the following due date, which date
may have been extended within limits specified in the Servicing Agreements. The
period of delinquency is based on the number of days payments are contractually
past due. Contracts less than 31 days delinquent are not included.
(3) Amount in repossession represents financed vehicles that have been
repossessed but not yet liquidated.

MFN
YEAR ENDED DECEMBER 31, 2002
----------------------------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding.................. $ 278,908
Net charge-offs as a percentage of average servicing
portfolio (2)............................................ 11.0%
- ------------
(1) All amounts and percentages are based on the principal amount scheduled to
be paid on each Contract, net of unearned income on pre-computed Contracts. The
information in the table represents all Contracts serviced by the Company.
(2) Net charge-offs include the remaining principal balance, after the
application of the net proceeds from the liquidation of the vehicle (excluding
accrued and unpaid interest).
(3) The fluctuation in net charge-offs as a percentage of the average servicing
portfolio between 2002 and 2001 is primarily due to the addition of MFN
Contracts, which are anticipated to charge off at rates greater than CPS
Contracts.
(4) The fluctuation in net charge-offs between 2001 and 2000 is primarily due to
the addition of Contracts held for the Company's own account, i.e., Contracts
purchased on an other than flow basis, in 2001, compared to the year over year
decrease in the Company's average servicing portfolio. During 2001, the Company
added new Contracts to its servicing portfolio. Newer Contracts would be
expected to have a lower percentage of charge-offs than more seasoned Contracts,
which would be approaching their peak losses and related charge-offs.
Additionally, the Company believes that the CPS Contracts originated during 2001
are of a higher credit quality than those originated in previous years.
FLOW PURCHASE PROGRAM
From May 1999 through the first quarter of 2002, the Company purchased Contracts
primarily for immediate and outright resale to non-affiliated third parties. The
Company sold such Contracts for a mark-up above what the Company paid the
Dealer. In such sales, the Company made certain representations and warranties
to the purchasers, normal in the industry, which related primarily to the
legality of the sale of the underlying motor vehicle and to the validity of the
security interest that conveyed to the purchaser. These representations and
warranties were generally similar to the representations and warranties given by
the originating Dealer to the Company. In the event of a breach of such
representations or warranties, the Company might incur liabilities in favor of
the purchaser(s) of the Contracts and there can be no assurance that the Company
would be able to recover, in turn, against the originating Dealer(s).
One of the two flow purchasers ceased to purchase Contracts in December 2001,
and the other ceased to purchase in May 2002. The flow purchase program
accordingly ended at that time.
9
SECURITIZATION AND SALE OF CONTRACTS
The Company purchases Contracts resale in securitization transactions. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and Note 1 of Notes to
Consolidated Financial Statements. The Company funds such purchases mostly with
proceeds from two warehouse lines of credit. These warehouse lines of credit
include a $125 million floating rate variable funding note facility, and a $75
million floating rate variable funding note facility. These facilities are
independent of each other, and are funded and insured by different institutions.
Approximately 73.0% and 72.5%, respectively, of the principal balance of
Contracts may be advanced to the Company under these facilities, subject to
collateral tests and certain other conditions and covenants.
Sales of Contracts to the facility-related special purpose subsidiaries are
treated as ongoing securitization sales. The lenders under those facilities have
the option to require a term securitization of the Contracts sold into the
warehouse facilities. Such options were exercised three times in 2002, resulting
in sales of Contracts in term securitization transactions conducted in March,
August and December 2002.
In a securitization sale, the Company is required to make certain
representations and warranties, which are generally similar to the
representations and warranties made by Dealers in connection with the Company's
purchase of the Contracts. If the Company breaches any of its representations or
warranties to a purchaser of the Contracts, the Company will be obligated to
repurchase the Contract from such purchaser at a price equal to such purchaser's
purchase price less the related cash securitization reserve and any payments
received by such purchaser on the Contract. The Company may then be entitled
under the terms of its Dealer Agreement to require the selling Dealer to
repurchase the Contract at a price equal to the Company's purchase price, less
any principal payments made by the customer. Subject to any recourse against
Dealers, the Company will bear the risk of loss on repossession and resale of
vehicles under Contracts repurchased by it.
Upon the sale of a portfolio of Contracts in a securitization transaction,
generally to a trust that is specifically created for such purpose ("Trust"),
the Company retains the obligation to service the Contracts, and receives a
monthly fee for doing so. Among other services performed, the Company mails to
obligors monthly billing statements directing them to mail payments on the
Contracts to a lockbox account. The Company engages an independent lockbox
processing agent to retrieve and process payments received in the lockbox
account. This results in a daily deposit to the Trust's bank account of the
entire amount of each day's lockbox receipts and the simultaneous electronic
data transfer to the Company of customer payment data records. Pursuant to the
Servicing Agreements, as defined below, the Company is required to deliver
monthly reports to the Trust reflecting all transaction activity with respect to
the Contracts. The reports contain, among other information, a reconciliation of
the change in the aggregate principal balance of the Contracts in the portfolio
to the amounts deposited into the Trust's bank account as reflected in the daily
reports of the lockbox processing agent.
In its securitization transactions, the Company generally warrants that, to the
best of the Company's knowledge, no such liens or claims are pending or
threatened with respect to a financed vehicle, that may be or become prior to or
equal with the lien of the related Contracts. In the event that any of the
Company's representations or warranties proves to be incorrect, the Trust would
be entitled to require the Company to repurchase the Contract relating to such
financed vehicle.
THE SERVICING AGREEMENTS
The Company currently services all Contracts that it owns, as well as those
Contracts included in portfolios that it has sold to securitization Trusts. The
Company does not service Contracts that were sold in its flow purchase program.
Pursuant to the Company's usual form of servicing agreement (the Company's
servicing agreements with purchasers of portfolios of Contracts are collectively
referred to as the "Servicing Agreements"), CPS is obligated to service all
10
Contracts sold to the Trusts in accordance with the Company's standard
procedures. The Servicing Agreements generally provide that the Company will
bear all costs and expenses incurred in connection with the management,
administration and collection of the Contracts serviced. The Servicing
Agreements also provide that the Company will take all actions necessary or
reasonably requested by the investor to maintain perfection and priority of the
Trust's security interest in the financed vehicles.
The Company is entitled under most of the Servicing Agreements to receive a base
monthly servicing fee of 2.5% per annum (5.0% per annum pursuant to the MFN
Securitization Agreements) computed as a percentage of the declining outstanding
principal balance of the non-defaulted Contracts in the portfolio. Each month,
after payment of the Company's base monthly servicing fee and certain other
fees, the Trust receives the paid principal reduction of the Contracts in its
portfolios and interest thereon at the fixed rate that was agreed when the
Contracts were sold to the Trust. If, in any month, collections on the Contracts
are insufficient to pay such amounts and any principal reduction due to
charge-offs, the shortfall is satisfied from the "Spread Account" established in
connection with the sale of the portfolio. The "Spread Account" is an account
established at the time the Company sells a portfolio of Contracts, to provide
security to the Note Insurers, as defined below. If collections on the Contracts
exceed such amounts, the excess is utilized, first, to build up or replenish the
Spread Account to the extent required, next, to cover deficiencies in Spread
Accounts for other portfolios, and the balance, if any, constitutes excess cash
flows, which are distributed to the Company.
Pursuant to the Servicing Agreements, the Company is generally required to
charge off the balance of any Contract by the earlier of the end of the month in
which the Contract becomes four scheduled installments past due or, in the case
of repossessions, the month that the proceeds from the liquidation of the
financed vehicle are received by the Company or if the vehicle has been in
repossession inventory for more than 90 days. In the case of a repossession, the
amount of the charge-off is the difference between the outstanding principal
balance of the defaulted Contract and the net repossession sale proceeds. In the
event collections on the Contracts are not sufficient to pay to the holders
("Investors") of interests in the Trust the entire principal balance of
Contracts charged off during the month, the trustee draws on the related Spread
Account to pay the Investors. The amount drawn would then have to be restored to
the Spread Account from future collections on the Contracts remaining in the
portfolio before the Company would again be entitled to receive excess cash. In
addition, the Company would not be entitled to receive any further monthly
servicing fees with respect to the defaulted Contracts. Subject to any recourse
against the Company in the event of a breach of the Company's representations
and warranties with respect to any Contracts and after any recourse to any
insurer guarantees backing the Notes, as defined below, the Investors bear the
risk of all charge-offs on the Contracts in excess of the Spread Account. The
Investors' rights with respect to distributions from the Trusts are senior to
the Company's rights. Accordingly, variation in performance of pools of
Contracts affects the Company's ultimate realization of value derived from such
Contracts.
The Servicing Agreements are terminable by the insurers of certain of the
Trust's obligations in the event of certain defaults by the Company and under
certain other circumstances. Were either of the Note Insurers in the future to
exercise its option to terminate the Servicing Agreements, such a termination
would have a material adverse effect on the Company's liquidity and results of
operations. The Company continues to receive Servicer extensions on a monthly
and/or quarterly basis, pursuant to the Servicing Agreements.
COMPETITION
The automobile financing business is highly competitive. The Company competes
with a number of national, regional and local finance companies with operations
similar to those of the Company. In addition, competitors or potential
competitors include other types of financial services companies, such as
commercial banks, savings and loan associations, leasing companies, credit
unions providing retail loan financing and lease financing for new and used
11
vehicles, and captive finance companies affiliated with major automobile
manufacturers such as General Motors Acceptance Corporation, Ford Motor Credit
Corporation, Chrysler Financial Corporation and Nissan Motors Acceptance
Corporation. Many of the Company's competitors and potential competitors possess
substantially greater financial, marketing, technical, personnel and other
resources than the Company. Moreover, the Company's future profitability will be
directly related to the availability and cost of its capital in relation to the
availability and cost of capital to its competitors. The Company's competitors
and potential competitors include far larger, more established companies that
have access to capital markets for unsecured commercial paper and investment
grade-rated debt instruments and to other funding sources that may be
unavailable to the Company. Many of these companies also have long-standing
relationships with Dealers and may provide other financing to Dealers, including
floor plan financing for the Dealers' purchase of automobiles from
manufacturers, which is not offered by the Company.
The Company believes that the principal competitive factors affecting a Dealer's
decision to offer Contracts for sale to a particular financing source are the
purchase price offered for the Contracts, the reasonableness of the financing
source's underwriting guidelines and documentation requests, the predictability
and timeliness of purchases and the financial stability of the funding source.
The Company believes that it can obtain from Dealers sufficient Contracts for
purchase at attractive prices by consistently applying reasonable underwriting
criteria and making timely purchases of qualifying Contracts.
GOVERNMENT REGULATION
Several federal and state consumer protection laws, including the federal
Truth-In-Lending Act, the federal Equal Credit Opportunity Act, the federal Fair
Debt Collection Practices Act and the Federal Trade Commission Act, regulate the
extension of credit in consumer credit transactions. These laws mandate certain
disclosures with respect to finance charges on Contracts and impose certain
other restrictions on Dealers. In many states, a license is required to engage
in the business of purchasing Contracts from Dealers. In addition, laws in a
number of states impose limitations on the amount of finance charges that may be
charged by Dealers on credit sales. The so-called Lemon Laws enacted by various
states provide certain rights to purchasers with respect to motor vehicles that
fail to satisfy express warranties. The application of Lemon Laws or violation
of such other federal and state laws may give rise to a claim or defense of a
customer against a Dealer and its assignees, including the Company and
purchasers of Contracts from the Company. The Dealer Agreement contains
representations by the Dealer that, as of the date of assignment of Contracts,
no such claims or defenses have been asserted or threatened with respect to the
Contracts and that all requirements of such federal and state laws have been
complied with in all material respects. Although a Dealer would be obligated to
repurchase Contracts that involve a breach of such warranty, there can be no
assurance that the Dealer will have the financial resources to satisfy its
repurchase obligations to the Company. Certain of these laws also regulate the
Company's servicing activities, including its methods of collection.
Although the Company believes that it is currently in material compliance with
applicable statutes and regulations, there can be no assurance that the Company
will be able to maintain such compliance. The past or future failure to comply
with such statutes and regulations could have a material adverse effect upon the
Company. Furthermore, the adoption of additional statutes and regulations,
changes in the interpretation and enforcement of current statutes and
regulations or the expansion of the Company's business into jurisdictions that
have adopted more stringent regulatory requirements than those in which the
Company currently conducts business could have a material adverse effect upon
the Company. In addition, due to the consumer-oriented nature of the industry in
which the Company operates and the application of certain laws and regulations,
industry participants are regularly named as defendants in litigation involving
alleged violations of federal and state laws and regulations and consumer law
torts, including fraud. Many of these actions involve alleged violations of
consumer protection laws. A significant judgment against the Company or within
the industry in connection with any such litigation could have a material
adverse effect on the Company's financial condition, results of operations or
liquidity. See "Legal Proceedings."
12
EMPLOYEES
As of December 31, 2002, the Company had 638 full-time and 5 part-time
employees, of whom 8 are senior management personnel, 388 are collections
personnel, 103 are Contract origination personnel, 50 are marketing personnel
(39 of whom are marketing representatives), 69 are operations and systems
personnel, and 25 are administrative personnel. The Company believes that its
relations with its employees are good. The Company is not a party to any
collective bargaining agreement.
ITEM 2. PROPERTY
The Company's headquarters are located in Irvine, California, where it leases
approximately 115,000 square feet of general office space from an unaffiliated
lessor. The annual rent is approximately $1.9 million through October 2003, and
increases to $2.1 million for the following five years. The Company has the
option to cancel the lease without penalty in October 2003. In addition to the
foregoing base rent, the Company pays the property taxes, maintenance and other
expenses of the premises.
In March 1997, the Company established a branch collection facility in
Chesapeake, Virginia. The Company leases approximately 28,000 square feet of
general office space in Chesapeake, Virginia, at a base rent that is currently
$419,470 per year, increasing to $504,545 over a ten-year term.
The remaining four regional servicing centers occupy a total of approximately
49,000 square feet of leased space in Orlando, Florida; Atlanta, Georgia;
Hinsdale, Illinois and Cleveland, Ohio. The termination dates of such leases
range from 2007 to 2008.
See Notes 2 and 14 of Notes to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
On May 12, 2000, Jon L. Kunert and Penny Kunert commenced a lawsuit against an
automobile dealer, the Company and in excess of 20 other defendants in the
Superior Court of California, Los Angeles County. The defendants other than the
automobile dealer appear to be various entities ("finance defendants") that may
have purchased retail installment contracts from that dealer. The lawsuit
alleges that the various finance defendants conspired with the automobile dealer
defendant to conceal from motor vehicle purchasers the full cost of credit
applicable to their purchases, and seeks a refund of the concealed excess cost.
The court subsequently ordered the plaintiffs to file separate lawsuits against
each finance defendant. Such a substitute lawsuit was filed against the Company
by Angela Hicks, on March 8, 2001. The lawsuits were dismissed with prejudice in
September 2001. The dismissal is currently on appeal.
On November 15, 2000, Denice and Gary Lang commenced a lawsuit against the
Company in South Carolina Common Pleas Court, Beaufort County, alleging that
they, and a purported nationwide class, were harmed by an alleged failure to
refer, in the notice given after repossession of their vehicle, of the right to
purchase the vehicle by tender of the full amount owed under the retail
installment contract. They seek damages in an unspecified amount.
On July 23, 1997, Elaine McLean commenced a lawsuit in the 134th District Court,
Dallas County, Texas against a subsidiary of MFN in the state of Texas alleging
deceptive practices related to various loans and the related purchase and sale
of insurance. The lawsuit seeks damages in an unspecified amount.
13
In 2001, the district court denied McLean's motion for class certification.
Later that same year, the appellate court denied McLean's appeal of the district
court ruling. The appellate court's denial is itself currently on appeal.
STANWICH LITIGATION. The Company is currently a defendant in a class action (the
"Stanwich Case") pending in the California Superior Court, Los Angeles County.
The plaintiffs in that case are persons entitled to receive regular payments
(the "Settlement Payments") under out-of-court settlements reached with third
party defendants. Stanwich Financial Services Corp. ("Stanwich"), an affiliate
of the former Chairman of the Board of Directors of the Company, is the entity
that is obligated to pay the Settlement Payments. Stanwich has defaulted on its
payment obligations to the plaintiffs and in June 2001 filed for reorganization
under the Bankruptcy Code, in the federal Bankruptcy Court of Connecticut. The
Company is also a defendant in certain cross-claims brought by other defendants
in the case, which assert claims of equitable and/or contractual indemnity
against the Company.
In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee,
asserted claims for indemnity against the Company in a separate action, which is
now pending in federal district court in Rhode Island. The Company has filed
counterclaims in the Rhode Island federal court against Mr. Pardee. The Company
plans to defend this matter and pursue its counterclaims vigorously.
In February 2002, the Company entered into a Term Sheet with Stanwich, the
plaintiffs in the Stanwich Case and others, which provides for the Company's
release upon its repayment of the amounts concededly owed to Stanwich, all of
which amounts have been recorded in the Company's financial statements as
indebtedness.
In February 2003, a court-sponsored mediation resulted in an agreement in
principle to settle the Stanwich Case (other than with respect to defendant
Pardee). The Company believes that the plaintiff's allegations and the
cross-claims brought by other defendants referenced above will be dismissed upon
final execution of such settlement.
MISSISSIPPI LITIGATION. On September 26, 2001, Maggie Chandler, Bobbie Mike and
Mary Ann Benford each commenced a lawsuit against subsidiaries of MFN in the
state of Mississippi. Chandler filed in Mississippi state court, county of
Leflore. Mike filed in Mississippi state court, county of Humphreys. Benford
filed in Mississippi state court, county of Holmes. Plaintiffs in all three
cases allege deceptive practices related to various loans and the related
purchase and sale of insurance, and seek unspecified damages. The Company
believes that there are substantive legal defenses to such claims, and intends
to defend them vigorously.
The outcome of any litigation is uncertain, and there is the possibility that
damages could be awarded against the Company in amounts that could be material.
It is management's opinion, based on the advice of counsel, that all litigation
of which it is aware, including the matters discussed above, will not have a
material adverse effect on the Company's consolidated financial position,
results of operations or liquidity, beyond reserves already taken.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Company's executive officers follows:
14
CHARLES E. BRADLEY, JR., 43, has been the President and a director of the
Company since its formation in March 1991. In January 1992, Mr. Bradley was
appointed Chief Executive Officer of the Company. From March 1991 until December
1995 he served as Vice President and a director of CPS Holdings, Inc. From April
1989 to November 1990, he served as Chief Operating Officer of Barnard and
Company, a private investment firm. From September 1987 to March 1989, Mr.
Bradley, Jr. was an associate of The Harding Group, a private investment banking
firm.
WILLIAM L. BRUMMUND, JR., 50, has been Senior Vice President - Operations since
March 1991. From 1986 to March 1991, Mr. Brummund was Vice President and Systems
Administrator for Far Western Bank, Tustin, California.
NICHOLAS P. BROCKMAN, 58, has been Senior Vice President - Asset Recovery &
Liquidation since January 1996. He was Senior Vice President of Contract
Originations from April 1991 to January 1996. From 1986 to March 1991, Mr.
Brockman served as a Vice President and Branch Manager of Far Western Bank.
CURTIS K. POWELL, 46, has been Senior Vice President - Contract Origination
since June 2001. Previously, he was the Company's Senior Vice President -
Marketing, from April 1995. He joined the Company in January 1993 as an
independent marketing representative until being appointed Regional Vice
President of Marketing for Southern California in November 1994. From June 1985
through January 1993, Mr. Powell was in the retail automobile sales and leasing
business.
MARK A. CREATURA, 43, has been Senior Vice President - General Counsel since
October 1996. From October 1993 through October 1996, he was Vice President and
General Counsel at Urethane Technologies, Inc., a polyurethane chemicals
formulator. Mr. Creatura was previously engaged in the private practice of law
with the Los Angeles law firm of Troy & Gould Professional Corporation, from
October 1985 through October 1993.
DAVID N. KENNEALLY, 40, has been Senior Vice President - Finance since July
2001. Previously, he was Chief Financial Officer of LoanGenie.com, Inc. from May
2000 to July 2001, and prior to that he served as Vice President - Financial
Reporting of Fidelity National Financial, Inc., from January 1994 through May
2000. From August 1992 through January 1994, Mr. Kenneally was Assistant Vice
President and Controller of Pacific States Casualty Company. Mr. Kenneally began
his professional career with KPMG LLP, leaving as a Senior Manager in July 1992.
ROD RIFAI, 36, has been Senior Vice President - Marketing since July 2001.
Previously, Mr. Rifai had served as the Company's Regional Vice President of
Marketing for the Southeast region, since December 1998, and as a marketing
representative from June 1997 to December 1998. Previous to that time Mr. Rifai
had been in the retail automobile sales and leasing business in various
management capacities for over ten years.
ROBERT E. RIEDL, 39, has been Senior Vice President - Risk Management since
January 2003. Mr. Riedl was a Principal at Northwest Capital Appreciation, a
middle market private equity firm, from 1999 to 2002. Mr. Riedl was an
investment banker for ContiFinancial Services Corporation from 1995 until
joining Northwest Capital Appreciation.
15
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market System, under
the symbol "CPSS." The following table sets forth the high and low sales prices
reported by Nasdaq for the Common Stock for the periods shown.
HIGH LOW
---- ---
January 1 - March 31, 2001.................................... $1.969 $1.438
April 1 - June 30, 2001....................................... 1.950 1.375
July 1 - September 30, 2001................................... 1.840 1.220
October 1 - December 31, 2001................................. 2.138 1.150
January 1 - March 31, 2002.................................... 2.000 1.110
April 1 - June 30, 2002....................................... 3.250 1.750
July 1 - September 30, 2002................................... 2.650 1.410
October 1 - December 31, 2002................................. 2.290 1.550
As of March 25, 2003, there were 84 holders of record of the Company's Common
Stock. To date, the Company has not declared or paid any dividends on its Common
Stock. The payment of future dividends, if any, on the Company's Common Stock is
within the discretion of the Board of Directors and will depend upon the
Company's income, its capital requirements and financial condition, and other
relevant factors. The instruments governing the Company's outstanding debt place
certain restrictions on the payment of dividends. The Company does not intend to
declare any dividends on its Common Stock in the foreseeable future, but instead
intends to retain any income for use in the Company's operations.
The table below presents information regarding outstanding options to purchase
the Company's Common Stock.

Included in the table above as being pursuant to equity compensation plans
approved by security holders are 1,589,200 options the Company has conditionally
granted, subject to shareholder approval of an increase in the number of shares
available for grant under its 1997 Long-Term Incentive Plan. All of such options
have an exercise price of $1.50 per share. Until and unless such shareholder
approval is gained, these options are not outstanding or exercisable. Excluding
such options, there would be 2,438,399 shares to be issued upon exercise of
outstanding options, the weighted average exercise price per share would be
$1.56, and there would be 620,851 options available for future issuance.
16

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(1) Beginning with the year ended December 31, 1999 and through December 31,
2000, the Company did not sell any Contracts in securitization transactions due
to then existing market conditions.
(2) On March 8, 2002, CPS acquired 100% of MFN Financial Corporation and
subsidiaries, resulting in the recognition of $17.4 million of negative goodwill
as an extraordinary gain, which is reflected in the Company's 2002 Consolidated
Statement of Operations.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following analysis of the financial condition of the Company should be read
in conjunction with "Selected Financial Data" and the Company's Consolidated
Financial Statements and the Notes thereto and the other financial data included
elsewhere in this report. The Company's Consolidated Balance Sheet and
Consolidated Statement of Operations as of and for the year ended December 31,
2002 include the results of operations of MFN Financial Corporation for the
period subsequent to March 8, 2002, the Merger date, through December 31, 2002.
See Note 2 of Notes to Consolidated Financial Statements.
OVERVIEW
Consumer Portfolio Services, Inc. and its subsidiaries (collectively, the
"Company") primarily engage in the business of purchasing, selling and servicing
retail automobile installment sale contracts ("Contracts") originated by
automobile dealers ("Dealers") located throughout the United States. Through its
purchase of Contracts, the Company provides indirect financing to Dealer
customers with limited credit histories, low incomes or past credit problems,
who generally would not be expected to qualify for financing provided by banks
or by automobile manufacturers' captive finance companies.
On March 8, 2002, the Company acquired 100% of MFN Financial Corporation, a
Delaware corporation ("MFN") and its subsidiaries, by the merger (the "Merger")
of CPS Mergersub, Inc., a Delaware corporation ("Mergersub") and a direct wholly
owned subsidiary of CPS, with and into MFN. In the Merger, MFN became a wholly
owned subsidiary of CPS. The Company thus acquired the assets of MFN, consisting
principally of interests in automobile installment sales finance Contracts and
the facilities for originating and servicing such Contracts. The Merger was
accounted for as a purchase. MFN, through its primary operating subsidiary,
Mercury Finance Company LLC, was engaged in business substantially similar to
that of the Company: purchasing automobile installment sales finance Contracts
from Dealers, and securitizing and servicing such Contracts.
The Company historically has generated revenue primarily from the gains
recognized on the sale or securitization of its Contracts, servicing fees earned
on Contracts sold, and interest earned on Residuals, as defined below, and on
finance receivables. In the years ended December 31, 1999 and 2000, the Company
did not sell any Contracts in securitization transactions, and therefore
recognized no gains on sale from securitization transactions. All sales of
Contracts during 1999 were on a servicing released basis, either in the form of
bulk sales of Contracts being held by the Company for sale, or as part of a flow
through agreement with a third party for which the Company earned fees on a per
Contract basis, also known as "the flow purchase program" or "purchases made on
a flow basis." During the year ended December 31, 2000, the Company entered into
another flow through agreement and proceeded to sell nearly all of the Contracts
purchased during the year to one or the other third party, for a mark-up above
what the Company paid the Dealer. The Company recorded a loss of $22.7 million
related to bulk sales in 1999. There were no bulk sales during 2000 or 2001. As
a result of the Company's flow through sales during the years ended December 31,
2002, 2001 and 2000, the Company recognized gain on sale of Contracts of $5.7
million, $16.6 million and $18.4 million, respectively. One of the two flow
purchasers ceased to purchase Contracts in December 2001, and the other has in
May 2002. The flow purchase program accordingly ended at that time.
18
The Company's securitization structure has generally been as follows:
The Company sells a portfolio of Contracts to a wholly owned Special Purpose
Subsidiary ("SPS"), which has been established for the limited purpose of buying
and reselling the Company's Contracts. The SPS then transfers the same Contracts
to an owner trust ("Trust"). The Trust is a qualifying special purpose entity as
defined in Statement of Financial Accounting Standards No. 140 ("SFAS 140"), and
is therefore not consolidated in the Company's Consolidated Financial
Statements. The Trust issues interest-bearing asset-backed securities (the
"Notes"), generally in a principal amount equal to the aggregate principal
balance of the Contracts. The Company typically sells these Contracts to the
Trust at face value and without recourse, except that representations and
warranties similar to those provided by the Dealer to the Company are provided
by the Company to the Trust. One or more investors purchase the Notes issued by
the Trust; the proceeds from the sale of the Notes are then used to purchase the
Contracts from the Company. The Company may retain subordinated Notes issued by
the Trust. The Company purchases a financial guaranty insurance policy,
guaranteeing timely payment of principal and interest on the senior Notes, from
an insurance company (the "Note Insurers"). In addition, the Company provides a
credit enhancement for the benefit of the Note Insurers and the investors in the
form of an initial cash deposit to an account ("Spread Account") held by the
Trust or in the form of subordinated Notes, or both. The agreements governing
the securitization transactions (collectively referred to as the "Securitization
Agreements") require that the initial deposits to the Spread Accounts be
supplemented by a portion of collections from the Contracts until the Spread
Accounts reach specified levels, and then maintained at those levels. The
specified levels are generally computed as a percentage of the principal amount
remaining unpaid under the related Notes. The specified levels at which the
Spread Accounts are to be maintained will vary depending on the performance of
the portfolios of Contracts held by the Trusts and on other conditions, and may
also be varied by agreement among the Company, the SPS, the Note Insurers and
the trustee. Such levels have increased and decreased from time to time based on
performance of the portfolios, and have also varied by Securitization Agreement.
The Securitization Agreements generally grant the Company the option to
repurchase the sold Contracts from the Trust when the aggregate outstanding
balance has amortized to 10% or less of the initial aggregate balance.
The Company's continuous securitization structure is similar to the above,
except that (i) the SPS that purchases the Contracts pledges the Contracts to
secure promissory notes issued directly by the SPS, (ii) the initial purchaser
of such notes has the right, but not the obligation, to require that the Company
repurchase the Contracts, (iii) the promissory notes are in an aggregate
principal amount of not more than 72.5% to 73% of the aggregate principal
balance of the Contracts (that is, up to 27.5% over-collateralization), and (iv)
no Spread Account is involved. The SPS is a qualifying special purpose entity
and is therefore not consolidated in the Company's Consolidated Financial
Statements.
Upon each sale of Contracts in a securitization, whether a term securitization
or a continuous securitization, the Company removes from its Consolidated
Balance Sheet the Contracts held for sale and adds to its Consolidated Balance
Sheet (i) the cash received and (ii) the estimated fair value of the ownership
interest that the Company retains in Contracts sold in the securitization. That
retained interest (the "Residual") consists of (a) the cash held in the Spread
Account, if any, (b) over collateralization, if any, (c) subordinated Notes
retained, if any, and (d) receivables from Trust, which include the net interest
receivables ("NIRs"). NIRs represent the estimated discounted cash flows to be
received from the Trust in the future, net of principal and interest payable
with respect to the Notes, and certain expenses. The excess of the cash received
and the assets retained by the Company over the carrying value of the Contracts
sold, less transaction costs, equals the net gain on sale of Contracts recorded
by the Company.
The Company allocates its basis in the Contracts between the Notes and the
Residuals sold and retained based on the relative fair values of those portions
on the date of the sale. The Company recognizes gains or losses attributable to
the change in the fair value of the Residuals, which are recorded at estimated
fair value. The Company is not aware of an active market for the purchase or
sale of interests such as the Residuals; accordingly, the Company determines the
estimated fair value of the Residuals by discounting the amount and timing of
anticipated cash flows that it estimates will be released to the Company in the
future (the cash out method), using a discount rate that the Company believes is
appropriate for the risks involved. The Company estimates the value of its
19
optional right to repurchase receivables pursuant to the terms of the
Securitization Agreements primarily based on its estimate of the amount and
timing of cash flows that it anticipates will be received from the repurchased
receivables following exercise of the optional right. The anticipated cash flows
include collections from both current and charged off receivables. The Company
has used an effective discount rate of approximately 14% per annum, which it
believes is appropriate for the risks involved.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Residuals that represent collections on the Contracts in excess
of the amounts required to pay principal and interest on the Notes, the base
servicing fees, and certain other fees (such as trustee and custodial fees).
Required principal payments are in most cases defined as the payments sufficient
to keep the principal balance of the Notes equal to the aggregate principal
balance of the related Contracts (excluding those Contracts that have been
charged off). Some of the Securitization Agreements require accelerated payment
of principal until the principal balance of the Notes is reduced to a specified
percentage of the aggregate principal balance of the related Contracts. Such
accelerated principal payment is said to create "over-collateralization" of the
Notes.
If the amount of cash required for payment of fees, interest and principal
exceeds the amount collected during the collection period, the shortfall is
drawn from the Spread Account, if any. If the cash collected during the period
exceeds the amount necessary for the above allocations, and there is no
shortfall in the related Spread Account, the excess is released to the Company,
or in certain cases is transferred to other Spread Accounts that may be below
their required levels. If the Spread Account balance is not at the required
credit enhancement level, then the excess cash collected is retained in the
Spread Account until the specified level is achieved. Although Spread Account
balances are held by the Trusts on behalf of the Company's SPS as the owner of
the Residuals, the cash in the Spread Accounts is restricted from use by the
Company. Cash held in the various Spread Accounts is invested in high quality,
liquid investment securities, as specified in the Securitization Agreements. The
interest rate payable on the Contracts is significantly greater than the
interest rate on the Notes. As a result, the Residuals described above are a
significant asset of the Company. In determining the value of the Residuals, the
Company must estimate the future rates of prepayments, delinquencies, defaults
and default loss severity, and the value of the Company's optional right to
repurchase receivables pursuant to the terms of the Securitization Agreements,
as all of these factors affect the amount and timing of the estimated cash
flows. The Company estimates prepayments by evaluating historical prepayment
performance of comparable Contracts. The Company has used prepayment estimates
of approximately 20% to 23% cumulatively over the lives of the related
Contracts. The Company estimates defaults and default loss severity using
available historical loss data for comparable Contracts and the specific
characteristics of the Contracts purchased by the Company. The Company estimates
recovery rates of previously charged off receivables using available historical
recovery data and projected future recovery levels. In valuing the Residuals,
the Company estimates that gross losses as a percentage of the original
principal balance will approximate 13% to 18% cumulatively over the lives of the
related Contracts, with recovery rates approximating 2% to 5% of the original
principal balance.
In future periods, the Company will recognize additional revenue from the
Residuals if the actual performance of the Contracts is better than the original
estimate, or the Company would increase the estimated fair value of the
Residuals. If the actual performance of the Contracts were worse than the
original estimate, then a downward adjustment to the carrying value of the
Residuals would be required.
The Noteholders and the related securitization Trusts have no recourse to the
Company for failure of the Contract obligors to make payments on a timely basis.
The Company's Residuals, however, are subordinate to the Notes until the
Noteholders are fully paid, and the Company is therefore at risk to that extent.
See "Critical Accounting Policies."
20
CRITICAL ACCOUNTING POLICIES
The Company believes that its accounting policies related to (a) Allowance for
Finance Credit Losses, (b) Residual Interest in Securitizations and Gain on Sale
of Contracts and (c) Income Taxes could be considered critical. Such policies
are described below.
(a) ALLOWANCE FOR FINANCE CREDIT LOSSES
In order to estimate an appropriate allowance for losses to be incurred on
finance receivables, the Company uses a loss reserving methodology commonly
referred to as "static pooling," which stratifies its finance receivable
portfolio into separately identified pools. Using analytical and formula driven
techniques, the Company estimates an allowance for finance credit losses, which
management believes is adequate for known and inherent losses in the finance
receivable Contract portfolio. Provision for loss is charged to the Company's
Consolidated Statement of Operations. Charge offs are charged to the allowance.
Management evaluates the adequacy of the allowance by examining current
delinquencies, the characteristics of the portfolio and the value of the
underlying collateral. As conditions change, the Company's level of provisioning
and/or allowance may change as well.
(b) RESIDUAL INTEREST IN SECURITIZATIONS AND GAIN ON SALE OF CONTRACTS
Gain on sale may be recognized on the disposition of Contracts either outright
or in securitization transactions. In its securitization transactions, a wholly
owned subsidiary of the Company retains a residual interest in the Contracts
that are sold. The Company's securitization transactions include "term"
securitizations (purchaser holds the Contracts for substantially their entire
term) and "continuous" securitizations (the Contracts sold may be put back to
the Company, and subsequently replaced with other Contracts).
The residual interest in term securitizations and the residual interest in the
Contracts sold continuously are reflected in the line item "residual interest in
securitizations" on the Company's Consolidated Balance Sheet. In either case,
the residual interest represents the discounted sum of expected future releases
from securitization trusts. Accordingly, the valuation of the residual is
heavily dependent on estimates of future performance.
The key economic assumptions used in measuring all retained interests remaining
as of December 31, 2002 and 2001 are included in the table below. The discount
rate remained constant at 14%.
2002 2001
-------------- --------------
Prepayment speed (Cumulative)................ 19.8% - 22.9% 22.0% - 27.2%
Credit losses (Cumulative)................... 10.0% - 15.4% 12.0% - 17.5%
21
Key economic assumptions and the sensitivity of the current fair value of
residual cash flows to immediate 10% and 20% adverse changes in those
assumptions are as follows:
DECEMBER 31, 2002
-----------------
(DOLLARS IN
THOUSANDS)
Carrying amount/fair value of residual interest in securitizations $127,170
Weighted average life in years ................................... 3.90
Prepayment Speed Assumption (Cumulative) ......................... 19.8% - 22.9%
Estimated fair value assuming 10% adverse change ................. $126,647
Estimated fair value assuming 20% adverse change ................. 126,144
Expected Credit Losses (Cumulative) .............................. 10.0% - 15.4%
Estimated fair value assuming 10% adverse change ................. $120,302
Estimated fair value assuming 20% adverse change ................. 113,424
Residual Cash Flows Discount Rate (Annual) ....................... 14.0%
Estimated fair value assuming 10% adverse change ................. $124,723
Estimated fair value assuming 20% adverse change ................. 122,351
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on 10% and 20% percent variation
in assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market rates may result in lower prepayments and
increased credit losses), which could magnify or counteract the sensitivities.
(c) INCOME TAXES
The Company and its subsidiaries file a consolidated federal income and combined
state franchise tax returns. The Company utilizes the asset and liability method
of accounting for income taxes, under which deferred income taxes are recognized
for the future tax consequences attributable to the differences between the
financial statement values of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date. The Company has estimated a valuation
allowance against that portion of the deferred tax asset whose utilization in
future periods is not more than likely.
22
In determining the possible realization of deferred tax assets, future taxable
income from the following sources are considered: (a) the reversal of taxable
temporary differences, (b) future operations exclusive of reversing temporary
differences, and (c) tax planning strategies that, if necessary, would be
implemented to accelerate taxable income into periods in which net operating
losses might otherwise expire.
See "Liquidity and Capital Resources" and Note 1 of Notes to Consolidated
Financial Statements.
MFN FINANCIAL CORPORATION ACQUISITION
MFN, through its primary operating subsidiary, Mercury Finance Company LLC, was
in the business of purchasing Contracts from Dealers, and securitizing and
servicing such Contracts. CPS intends to continue to use the assets acquired in
the Merger in the automobile finance business, but a portion of such assets have
been disposed of. CPS has ceased to use the acquired assets for the purchase of
Contracts, and does not anticipate recommencing such use. In connection with the
termination of MFN origination activities and the integration and consolidation
of other activities, the Company recognized as a liability its estimate of the
costs to exit these activities and terminate the affected employees of MFN. The
terminated activities include service departments such as accounting, finance,
human resources, information technology, administration, payroll and executive
management. The estimated costs include the following:

- ------------
(1) Activity resulting in a net charge $157,000 includes charges against
liability of $1.4 million, and the "reclassification" of an existing accrual for
offices closed prior to the Merger Date of approximately $1.2 million.
(2) Approximately $2.9 million of remaining accrual is recorded in the
Consolidated Balance Sheet of the Company at December 31, 2002. The Company
believes that this amount provides adequately for anticipated remaining costs
related to exiting certain activities of MFN, and that amounts indicated above
are reasonably allocated.
Upon effectiveness of the Merger, each outstanding share of common stock of MFN
converted into the right to receive $10.00 per share in cash. The total Merger
consideration payable to stockholders of MFN was approximately $99.9 million.
The amount of such consideration was agreed to as the result of arms'-length
negotiations between CPS and MFN. The aggregate purchase price, including
expenses related to the transaction, was approximately $123.2 million.
Acquisition financing was provided to CPS by Westdeutsche Landesbank
Girozentrale, New York Branch ("WestLB") and Levine Leichtman Capital Partners
II, L.P ("LLCP"). CPS obtained acquisition financing from LLCP through its
issuance and sale of certain senior secured notes to LLCP in the aggregate
principal amount of $35 million.
The Company's Consolidated Balance Sheet and Consolidated Statement of
Operations as of and for the year ended December 31, 2002 include the results of
operations of MFN for the period subsequent to March 8, 2002, the Merger date.
23
The Company has recorded certain purchase accounting adjustments recorded on its
Consolidated Balance Sheet, which are estimates based on available information.
In addition, the Company's Consolidated Statement of Operations for the year
ended December 31, 2002 includes an extraordinary gain related to the excess of
net assets acquired over purchase price ("negative goodwill") totaling $17.4
million.
RESULTS OF OPERATIONS
THE YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE YEAR ENDED DECEMBER 31, 2001
REVENUE. During the year ended December 31, 2002, revenues increased $29.9
million, or 48.3%, compared to the year ended December 31, 2001. Net gain on
sale of Contracts decreased by $16.3 million, from $32.8 million for the year
ended December 31, 2001, to $16.4 million for the year ended December 31, 2002.
The primary reason for the decrease in the gain on sale component of revenue is
the termination of the Company's flow purchase program in May 2002, offset in
part by an increase in the amount of Contracts securitized by the Company in
2002 compared to 2001. The Company securitized $281.2 million of Contracts
during the year ended December 31, 2002, compared to $141.7 million during the
year ended December 31, 2001. During the year ended December 31, 2002, the
Company sold $181.1 million of Contracts on a flow basis compared to $537.9
million of Contracts in the year ended December 31, 2001.
Gain on sale of Contracts also includes the effect of fluctuations in the
Company's estimate of the required provision for losses on certain CPS Contracts
and recovery of losses on such Contracts. During 2001, recoveries exceeded the
provision for losses; in 2002 the provision for losses was greater than
recoveries. During 2002, the amount of Contracts for which the Company recorded
a provision for Contract losses has increased, requiring the Company to provide
for losses on such Contracts in an amount exceeding related recoveries. For the
year ended December 31, 2002 the Company recorded a $2.6 million provision for
Contract losses, compared to a reduction of the provision for Contract losses of
$5.7 million for the year ended December 31, 2001. Also during 2002, as a result
of revised Company estimates resulting from analyses of the current and
historical performance of certain of the Company's securitized pools, the
Company recorded a reduction to gain on sale of approximately $2.0 million.
Interest income increased $31.4 million to $48.6 million in the year ended
December 31, 2002, from $17.2 million in the prior year. The increase in
interest income is primarily due to the expansion of the Company's servicing
portfolio, primarily as a result of the MFN Merger, as well as the addition of
Contracts to the CPS portfolio and the related increase in the Company's
residual interest in securitizations as a result of the increased level of
securitizations. As of December 31, 2002, the servicing portfolio, net of
unearned income on pre-computed Contracts, was $595.2 million, compared to
$285.5 million as of December 31, 2001.
Servicing fees increased by $4.0 million, or 37.1%, to $14.6 million for the
year ended December 31, 2002, from $10.7 million for the year ended December 31,
2001. Servicing fees are composed of base fees, which are payable at the rate of
2.5% per annum on the principal balance of the outstanding CPS Contracts (5.0%
on MFN Contracts) in the related Trusts, plus any other fees collected by the
Company, such as late fees and returned check fees. The increase in servicing
fees is primarily due to the increase in the Company's servicing portfolio.
EXPENSES. During the year ended December 31, 2002, operating expenses increased
by $30.2 million, or 49.0%, to $91.9 million, compared to the year ended
December 31, 2001 operating expenses of $61.7 million. The Company's operating
expenses consist primarily of personnel costs and other operating expenses,
which are incurred as applications and Contracts are received, processed and
24
serviced. Factors that affect margins and net income include changes in the
automobile and automobile finance market environments, macroeconomic factors
such as interest rates, and mix of business between Contracts purchased on a
flow basis and Contracts purchased on an other than flow basis. The overall
increase in expenses is primarily attributable to the MFN Merger. Personnel
costs increased $13.8 million, or 57.4%, to $37.8 million in 2002 from $24.0
million in 2001. Personnel costs include base salaries, commissions and bonuses
paid to employees, and certain expenses related to the accounting treatment of
outstanding warrants and stock options, and are the Company's most significant
operating expenses, representing approximately 41.1% of 2002 operating expenses.
These costs generally fluctuate with the level of applications and Contracts
processed and serviced, with the mix of revenue and with overall portfolio
performance. Other material operating expenses include facilities expenses,
telephone and other communication services, credit services, computer services
(including personnel costs associated with information technology support),
professional services, marketing and advertising expenses, and depreciation and
amortization.
In connection with the termination of MFN origination activities and the
integration and consolidation of certain activities (see above), the Company has
recognized certain liabilities related to the costs to exit these activities and
terminate the affected employees of MFN. These activities include service
departments such as accounting, finance, human resources, information
technology, administration, payroll and executive management. Such exit and
termination costs have been charged against these liabilities and are not
reflected in the Company's Consolidated Statement of Operations.
General and administrative expenses increased by $7.5 million, or 59.2%, and
represented 21.9% of total operating expenses. The increase in general and
administrative expenses is primarily due to the MFN Merger and an increase in
costs associated with servicing the Company's expanded portfolio. Also included
in 2002 general and administrative expenses is $669,000 related to the write off
a related party receivable from CARSUSA, Inc. See Note 13 of Notes to
Consolidated Financial Statements.
Interest expense increased by $9.6 million, or 66.9%, and represented 26.0% of
total operating expenses. The increase is due to the interest expense resulting
from the MFN acquisition, including interest expense related to acquisition debt
and the interest expense related to the Notes Payable to Securitization Trust.
See "Liquidity and Capital Resources."
Marketing expenses decreased by $1.6 million, or 25.0%, and represented 5.3% of
total operating expenses. The decrease is primarily due to the decrease in
Contracts purchased during the year ended December 31, 2002.
Occupancy expenses increased by $860,000, or 27.2%, and represented 4.4% of
total operating expenses. The increase is primarily due to the addition of
facilities acquired in the MFN Merger.
Depreciation and amortization expenses increased by $119,000, or 11.7%, and
represented 1.2% of total operating expenses.
The results for the years ended December 31, 2002 and 2001, include net income
of $116,732 and $161,710, respectively, from the Company's subsidiary CPS
Leasing, Inc.
Income tax benefit of $2.9 million, including the elimination of the valuation
allowance of $3.2 million, was recorded in the 2002 period pursuant to relevant
tax statutes and regulations. The Company's provision for income taxes was zero
for the year ended December 31, 2001.
25
THE YEAR ENDED DECEMBER 31, 2001 COMPARED TO THE YEAR ENDED DECEMBER 31, 2000
REVENUE. During the year ended December 31, 2001, revenues increased $26.1
million, or 72.5%, compared to the year ended December 31, 2000. Net gain on
sale of Contracts increased by $16.5 million, from $16.2 million for the year
ended December 31, 2000, to $32.8 million for the year ended December 31, 2001.
The primary reason for the increase in the gain on sale component of revenue is
the Company's securitization of approximately $141.7 million of Contracts in the
2001 period, resulting in a gain on sale of Contracts of $9.2 million. The
availability and structure of the Company's note purchase facility enabled it to
execute securitization sales during 2001; no such sales occurred in the prior
year. In addition, the Company completed a term securitization in September
2001. Substantially all of the proceeds from the September 2001 transaction were
used to reduce amounts outstanding under the Company's floating rate variable
note purchase facility. Additionally, gain on sale of Contracts includes the
effect of fluctuations in the Company's estimate of the required provision for
losses on Contracts and in recoveries of losses on Contracts. During 2001,
recoveries exceeded the provision for losses; in 2000 the provision for losses
was greater than recoveries. The Company makes recoveries on Contracts
previously held on balance sheet or from pools for which the Company has
exercised its optional right to repurchase receivables pursuant to the
Securitization Agreements. The amount of Contracts for which the Company
requires a provision for Contract losses has contracted, while the amount
recovered increased. As such the Company is able to recover its provision for
Contract losses. For the year ended December 31, 2001 the Company recorded a
reduction of the provision for Contract losses of $5.7 million, compared to a
charge of $1.8 million for the year ended December 31, 2000.
During the year ended December 31, 2001, the Company sold $537.9 million of
Contracts on a flow basis compared to $600.4 million of Contracts in the year
ended December 31, 2000. The Company's flow purchase program ended in May 2002.
Interest income increased $13.7 million to $17.2 million in the year ended
December 31, 2001, from $3.5 million in the prior year. The increase in interest
income is primarily due to the increase in residual interest income resulting
from a change in the method residual interest income was calculated beginning in
the second quarter of 2000. The increase in residual interest income is due to
the Company refining its methodology of calculation of such interest income
beginning with the three-month period ended June 30, 2000. The refined method is
designed to accrete residual interest income on a level yield basis. The Company
now uses an accretion rate that approximates the discount rate used to value the
residual interest in securitizations, approximately 14% per annum. Prior to such
period, the Company recognized residual interest income as the excess cash flows
generated by the Trusts over the related obligations of the Trusts, net of any
amortization of the related NIRs. This prior method of residual interest income
recognition had approximated a level yield rate of residual interest income due
to the continued addition of new securitizations. Since the Company had not
securitized any Contracts since December 1998, this prior method would not have
reflected the appropriate level yield and thus was refined during the second
quarter of 2000. The effect of this refinement has been offset, in part, by the
contraction of the Company's servicing portfolio.
Servicing fees decreased by $5.2 million, or 32.7%, to $10.7 million for the
year ended December 31, 2001, from $15.8 million for the year ended December 31,
2000. Servicing fees are composed of base fees, which are payable at the rate of
2% to 2.5% per annum on the principal balance of the outstanding Contracts in
the related Trusts, plus any other fees collected by the Company, such as late
fees and returned check fees. The decrease in servicing fees is primarily due to
the decrease in the Company's servicing portfolio. As of December 31, 2001, the
servicing portfolio, net of unearned income on pre-computed Contracts, was
$285.5 million, compared to $411.9 million as of December 31, 2000.
26
EXPENSES. During the year ended December 31, 2001, operating expenses decreased
by $6.7 million, or 9.8%, compared to the year ended December 31, 2000.
Personnel costs were effectively flat year over year, decreasing $640,000, or
2.6%, to $24.0 million in 2001 from $24.6 million in 2000. Personnel costs
include base salaries, commissions and bonuses paid to employees, and certain
expenses related to the accounting treatment of outstanding warrants and stock
options, and are the Company's most significant operating expenses, representing
approximately 38.9% of total operating expenses. These costs generally fluctuate
with the level of applications and Contracts processed and serviced, with the
mix of revenue and with overall portfolio performance. Other material operating
expenses include facilities expenses, telephone and other communication
services, credit services, computer services (including personnel costs
associated with information technology support), professional services,
marketing and advertising expenses, and depreciation and amortization. General
and administrative expenses decreased by $3.1 million, or 19.8%, and represented
20.5% of total operating expenses. The decrease in general and administrative
expenses is primarily due to the decrease in costs associated with servicing the
Company's diminished portfolio.
Interest expense decreased by $2.9 million, or 16.9%, and represented 23.2% of
total operating expenses. The decrease in interest expense is primarily due to
the reductions in non-warehouse indebtedness from the prior year. See "Liquidity
and Capital Resources."
Marketing expenses increased by $399,000, or 6.5%, and represented 10.6% of
total operating expenses. The increase is primarily due to the increase in
Contracts purchased during the year ended December 31, 2001.
Occupancy expenses decreased by $241,000, or 7.1%, and represented 5.1% of total
operating expenses. The decrease is primarily due to additional property taxes
paid during 2000, not due in 2001. In November 1998, the Company moved its
headquarters to a new 115,000 square foot facility. Depreciation and
amortization expenses decreased by $142,000, or 12.2%, and represented 1.7% of
total operating expenses.
The results for the years ended December 31, 2001 and 2000, include net earnings
of $161,710 and $19,816, respectively, from the Company's subsidiary CPS
Leasing, Inc. The increase in net income of CPS Leasing, Inc. is primarily
attributable to the decision to cease lease receivable origination and to simply
service the existing receivables, resulting in significant expense reductions.
The results for the year ended December 31, 2000, include net operating losses
of $755,000 from the Company's investment in 38% of NAB Asset Corp.
The Company's effective tax rate was zero and 31.7%, for the years ended
December 31, 2001 and 2000, respectively.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
The Company's business requires substantial cash to support its purchases of
Contracts and other operating activities. The Company's primary sources of cash
have been cash flows from operating activities, including proceeds from sales of
Contracts, amounts borrowed under various revolving credit facilities (also
sometimes known as warehouse credit facilities), servicing fees on portfolios of
Contracts previously sold, customer payments of principal and interest on
Contracts held for sale, fees for origination of Contracts, and releases of cash
27
from credit enhancements provided by the Company for the financial guaranty
insurers (Note Insurers) and Investors, initially made in the form of a cash
deposit to an account (Spread Account), and releases of cash from securitized
pools of Contracts in which the Company has retained a residual ownership
interest. The Company's primary uses of cash have been the purchases of
Contracts, repayment of amounts borrowed under lines of credit and otherwise,
operating expenses such as employee, interest, occupancy expenses and other
general and administrative expenses, the establishment of and further
contributions to "Spread Accounts" (cash posted to enhance credit of securitized
pools), and income taxes. There can be no assurance that internally generated
cash will be sufficient to meet the Company's cash demands. The sufficiency of
internally generated cash will depend on the performance of securitized pools
(which determines the level of releases from Spread Accounts), the rate of
expansion or contraction in the Company's servicing portfolio, and the terms
upon which the Company is able to acquire, sell, and borrow against Contracts.
Net cash provided by operating activities for the years ended December 31, 2002,
2001 and 2000, was $146.9 million, $3.7 million and $38.7 million, respectively.
Cash from operating activities is generally provided by the net releases from
the Company's securitization Trusts and from the amortization and liquidation of
Contracts. Such amortization and liquidation of Contracts increased in 2002
compared to prior years as a result of the MFN Merger and the addition of
Contracts to the CPS servicing portfolio and related increase in securitization
transactions. On March 8, 2002, the Company completed the MFN Merger (See Note 2
of Notes to Consolidated Financial Statements.). The acquisition cost was
approximately $123.2 million, and was substantially funded by existing cash and
borrowings. Cash flows from the underlying purchased assets are expected to
provide adequate liquidity to fund the acquisition borrowings, as well as
generate positive cash flows from which to fund the Company's operating
activities.
Net cash used in investing activities for the years ended December 31, 2002,
2001 and 2000, was $29.8 million, $536,000 and $623,000, respectively. Cash used
in the acquisition of MFN Financial Corporation, net of the cash acquired in the
transaction, totaled $29.5 million.
Net cash used in financing activities for the years ended December 31, 2002,
2001 and 2000, was $86.8 million, $19.7 million and $20.4 million, respectively.
In connection with the acquisition of MFN Financial Corporation the Company
incurred debt related to the MFN 2001-A Securitization Trust (See Note 7 of
Notes to Consolidated Financial Statements.) and additional senior secured debt
(See Note 8 of Notes to Consolidated Financial Statements.). Cash used in
financing activities is primarily attributable to the repayment of outstanding
debt. In connection with the MFN Merger the amount of outstanding debt,
securitization trust debt and senior secured debt, and the required repayment
thereof, increased compared to prior years.
The Company believes that cash flows generated as a result of the acquisition of
MFN Financial Corporation will be sufficient to meet the obligations incurred as
a result of the Merger. There can be no assurance that internally generated cash
will be sufficient to meet such cash demands. The sufficiency of internally
generated cash will depend on the performance of the securitized pools. At the
time of the Merger, MFN had outstanding $22.5 million in principal amount of
senior subordinated debt, which was due and repaid in full on March 23, 2002.
Such debt bore interest at the rate of 11.00% per annum, payable quarterly in
arrears.
Contracts are purchased from Dealers for a cash price approximating their
principal amount, and generate cash flow over a period of years. As a result,
the Company has been dependent on warehouse credit facilities to purchase
Contracts, and on the availability of cash from outside sources in order to
finance its continuing operations, as well as to fund the portion of Contract
purchase prices not financed under warehouse credit facilities. During 2001 and
through May 2002, the Company's Contract purchasing program consisted of both
(i) purchases for the Company's own account made on other than a flow basis,
28
funded primarily by advances under a revolving warehouse credit facility, and
(ii) flow purchases for immediate resale to non-affiliates. Flow purchases
allowed the Company to purchase Contracts with minimal demands on liquidity. The
Company's revenues from the resale of flow purchase Contracts, however, were
materially less than those that may be received by holding Contracts to maturity
or by selling Contracts in securitization transactions. During the year ended
December 31, 2002, the Company purchased $181.1 million of Contracts on a flow
basis, and $282.2 million on an other than flow basis for its own account,
compared to $537.9 million and $134.4 million, respectively, of Contracts
purchased in 2001. For the year ended December 31, 2000, the Company purchased
$600.4 million of Contracts on a flow basis and $31.1 million on an other than
flow basis. The Company's flow purchase program ended in May 2002.
During the years ended December 31, 2002 and 2001, the Company purchased
Contracts to for resale into securitization transactions. The Company did not
sell Contracts in a securitization transaction during 2000 or 1999; however,
since November 2000, the Company has been able to purchase Contracts for its own
account, which are generally resold into a term securitization transaction,
using proceeds from two warehouse lines of credit. These warehouse lines of
credit consist of a $125 million floating rate variable funding note facility,
and a $75 million floating rate variable funding note facility. These facilities
are independent of each other, and are funded and insured by different
institutions. Approximately 73.0% and 72.5%, respectively, of the principal
balance of Contracts may be advanced to the Company under these facilities,
subject to collateral tests and certain other conditions and covenants.
The $125 million warehouse facility is structured to allow CPS to fund a portion
of the purchase price of Contracts by drawing against a floating rate variable
funding note issued by CPS Warehouse Trust. This facility was established in
March 7, 2002, in the maximum amount of $100 million. Such maximum amount was
increased to $125 million in November 2002. Approximately 73% of the principal
balance of Contracts may be advanced to the Company under this facility, subject
to collateral tests and certain other conditions and covenants. Notes under this
facility bear interest at a rate of one-month Commercial Paper plus 1.18% per
annum. This facility was renewed on March 6, 2003.
The $75 million warehouse facility is structured to allow CPS to fund a portion
of the purchase price of Contracts by drawing against a floating rate variable
funding note issued by CPS Funding LLC. Approximately 72.5% of the principal
balance of Contracts may be advanced to the Company under this facility subject
to collateral tests and certain other conditions and covenants, notes under this
facility bear interest at a rate of one-month LIBOR plus 0.60% per annum.
These facilities are independent of each other, and are funded and insured by
different institutions. Sales of Contracts to the facility-related special
purpose subsidiaries ("SPS") are treated as ongoing securitizations. The
Company, therefore, removes the securitized Contracts and related debt from its
Consolidated Balance Sheet and recognizes a gain on sale in the Company's
Consolidated Statement of Operations. The Company securitized $281.2 million of
Contracts during the year ending December 31, 2002, resulting in a gain on sale
of $16.9 million, compared to $141.7 million of Contracts securitized during
the year ending December 31, 2001, resulting in a gain on sale of $9.2 million.
The Company completed a $68.5 million term securitization (through its
subsidiary, CPS Receivables Corp.) on September 7, 2001, retaining a residual
interest therein. In a private placement, qualified institutional buyers
purchased notes backed by automotive receivables. The notes, issued by CPS Auto
Receivables Trust 2001-A, consist of two classes: $44.5 million of 4.37% Class
A-1 Notes, and $24.0 million of 5.28% Class A-2 Notes. The Company completed an
additional securitization (through its subsidiary, CPS Receivables Corp.) on
March 8, 2002, retaining a residual interest therein. In that transaction,
$45.65 million of notes backed by automotive receivables were issued in a
private placement to qualified institutional buyers by CPS Auto Receivables
Trust 2002-A. The notes
29
consist of two classes: $26.5 million of 3.741% Class A-1 Notes, and $19.15
million of 4.814% Class A-2 Notes. In both transactions, the Class A-1 and A-2
Notes, rated AAA/Aaa by Standard and Poor's and Moody's, were priced at par.
Substantially all of the proceeds from the September 2001 and the March 2002
transaction were used to reduce amounts outstanding under the CPS Funding LLC
floating rate variable note purchase facility.
On August 22, 2002, CPS (through its subsidiary, CPS Receivables Two Corp.) sold
Contracts to CPS Auto Receivables Trust 2002-B in a private placement
securitization transaction, retaining a residual interest therein. In this
transaction, qualified institutional buyers purchased $130.48 million of notes
backed by automotive Contracts that were originated by Consumer Portfolio
Services. The Notes, issued by CPS Auto Receivables Trust 2002-B, consist of two
classes: $50.24 million of 2.00% Class A-1 Notes, and $80.24 million of 3.50%
Class A-2 Notes. CPS completed another securitization (through its subsidiary,
CPS Receivables Two Corp.) on December 19, 2002, by selling automobile
installment sales finance Contracts to CPS Auto Receivables Trust 2002-C in a
private placement securitization transaction, retaining a residual interest
therein. In this transaction, qualified institutional buyers purchased $99.30
million of notes backed by automotive Contracts that were originated by Consumer
Portfolio Services. The Notes, issued by CPS Auto Receivables Trust 2002-C,
consist of two classes: $30.78 million of 1.90% Class A-1 Notes, and $68.52
million of 3.52% Class A-2 Notes. In both the CPS Warehouse Trust transactions,
the Class A-1, rated A1+/Prime-1 by Standard and Poor's and Moody's, and A-2
Notes, rated AAA/Aaa, were priced at par. The proceeds from the August 2002 and
the December 2002 transaction were used to reduce amounts outstanding under the
CPS Warehouse Trust floating rate variable note purchase facility and for
general corporate purposes.
The Company previously purchased Contracts on a flow basis, which, as compared
with purchases of Contracts for the Company's own account, involved a materially
reduced demand on the Company's cash. The Company's plan for meeting its
liquidity needs is to match its levels of Contract purchases to its availability
of cash.
Cash used for subsequent deposits to Spread Accounts for the years ended
December 31, 2002, 2001 and 2000, was $24.2 million, $24.6 million and $15.0
million, respectively. Cash released from Spread Accounts to the Company for the
years ended December 31, 2002, 2001 and 2000, was $60.4 million, $43.7 million
and $80.6 million, respectively. Changes in deposits to and releases from Spread
Accounts are affected by the relative size, seasoning and performance of the
various pools of Contracts sold that make up the Company's servicing portfolio
to which the respective Spread Accounts are related. During the year ended
December 31, 2002 the Company made initial deposits to the related Spread
Accounts of $16.7 million related to its term securitization transactions,
compared to $2.5 million in the 2001 period. No such initial deposits were made
in 2000, as there were no securitizations during that year. The acquisition of
Contracts for subsequent sale in securitization transactions, and the need to
fund Spread Accounts when those transactions take place, results in a continuing
need for capital. The amount of capital required is most heavily dependent on
the rate of the Company's Contract purchases (other than flow purchases), the
required level of initial credit enhancement in securitizations, and the extent
to which the previously established Spread Accounts either release cash to the
Company or capture cash from collections on sold Contracts. The Company is
currently limited in its ability to purchase Contracts due to certain liquidity
constraints. As of December 31, 2002, the Company had cash on hand of $32.9
million and available Contract purchase commitments from its warehouse credit
facilities of $53.2 million. The Company received an additional Contract
purchase commitment from its CPS Funding LLC warehouse credit facility of $75
million upon closing in January 2003. The Company's plans to manage the need for
liquidity include the completion of additional term securitizations that would
provide additional credit availability from the warehouse credit facilities, and
matching its levels of Contract purchases to its availability of cash. There can
be no assurance that the Company will be able to complete the term
securitizations on favorable economic terms or that the Company will be able to
complete term securitizations at all. If the Company is unable to complete such
securitizations, servicing fees and other portfolio related income would
decrease.
30
The Company's ability to adjust the quantity of Contracts that it purchases and
sells will be subject to general competitive conditions and the continued
availability of the floating rate variable note purchase facilities. There can
be no assurance that the desired level of Contract acquisition can be maintained
or increased. Obtaining releases of cash from the Spread Accounts is dependent
on collections from the related Trusts generating sufficient cash to maintain
the Spread Accounts in excess of the amended specified levels. There can be no
assurance that collections from the related Trusts will generate cash in excess
of the amended specified levels.
Certain of the Company's securitization transactions and the CPS Warehouse Trust
floating rate variable note purchase facility contain various covenants
requiring certain minimum financial ratios and results. The Company was in
compliance with these covenants as of the date of this report.
CREDIT FACILITIES
The terms on which credit has been available to the Company for purchase of
Contracts have varied over the three-year period ended December 31, 2002, as
shown in the following recapitulation:
In November 2000, the Company (through its subsidiary CPS Funding LLC) entered
into a floating rate variable note purchase facility under which up to $75
million of notes may be outstanding at any time subject to collateral tests and
other conditions. The Company uses funds derived from this facility to purchase
Contracts, which are pledged to secure the notes. The collateral tests and other
conditions generally allow the Company to borrow up to approximately 72.5% of
the price paid for such Contracts. Notes issued under this facility bear
interest at one-month LIBOR plus 0.75% per annum. The balance of notes
outstanding related to this facility at December 31, 2001 was zero. This
facility was renewed and restated in January 2003.
Additionally, in March 2002, the Company (through its subsidiary CPS Warehouse
Trust) entered in to a second floating rate variable note purchase facility,
under which up to $125.0 million of notes may be outstanding at any time,
subject to collateral tests and other conditions. The Company uses funds derived
from this facility to purchase Contracts, which are pledge to secure the notes.
The collateral tests and other conditions generally allow the Company to borrow
up to approximately 73% of the price paid for such Contracts. Notes issued under
this facility bear interest at commercial paper plus 1.18% per annum. The
balance of notes outstanding related to this facility at December 31, 2002 was
$71.8 million. This facility was renewed on March 6, 2003.
CAPITAL RESOURCES
Prior to 1999, and again in 2001 and 2002, the Company has funded increases in
its servicing portfolio through off balance sheet securitization transactions,
as discussed above, and funded its other capital needs with cash from operations
and with the proceeds from the issuance of long-term debt and/or equity.
The acquisition of Contracts for subsequent sale in securitization transactions,
and the need to fund Spread Accounts when those transactions take place, results
in a continuing need for capital. The amount of capital required is most heavily
dependent on the rate of the Company's Contract purchases (other than purchases
made on a flow basis), the required level of initial credit enhancement in
securitizations, and the extent to which the Spread Accounts either release cash
to the Company or capture cash from collections on sold Contracts. The Company
plans to adjust its levels of Contract purchases so as to match anticipated
releases of cash from Spread Accounts with its capital requirements.
31
CAPITALIZATION
Over the three-year period ended December 31, 2002, the Company has managed its
capitalization by issuing and restructuring debt and issuing/purchasing common
stock and equivalents, as summarized in the following table:

The issuance and assumption of debt related to the MFN Merger is included in the
2002 activity in the table above.
The following review of the terms of such issuances of debt and equity shows
that the Company's cost of capital was relatively consistent between 2000 and
2002. There were no material issuances in 2001.
In March 2000, the Company and Levine Leichtman Capital Partners II, L.P.
("LLCP") restructured the outstanding indebtedness of the Company in favor of
LLCP, which had been in default. In the restructuring (i) all existing defaults
were waived or cured, (ii) LLCP lent an additional $16 million ("Term A") to the
Company, (iii) the proceeds of that loan (net of fees and expenses) were used to
repay all of the Company's outstanding senior secured indebtedness, (iv) the
outstanding $30 million of subordinated indebtedness in favor of LLCP was
exchanged for senior indebtedness ("Term B"), (v) the Company granted a blanket
security interest in favor of LLCP, to secure both Term A and Term B, and (vi)
LLCP released Stanwich Financial Services Corp. ("SFSC"), an affiliate of the
then Chairman of the Company's Board of Directors (Mr. Charles E. Bradley, Sr.),
and its affiliates (including Mr. Bradley, Sr., Mr. Bradley, Jr., and Mr. Poole,
directors of the Company) of any liability for failure to invest $15 million in
the Company. Term A has been repaid in accordance with its terms; Term B is due
November 2003, and bears interest at 14.50% per annum. In each case the interest
32
rate is subject to increase by 2.0% in the event of a default by the Company. In
the restructuring, the Company paid a fee of $325,000, paid accrued default
interest of $300,000, issued 103,500 shares of common stock to LLCP, and paid
out-of-pocket expenses of approximately $214,000. The shares of common stock
issued were valued at approximately $155,000, were included in deferred interest
expense, and are being amortized over the life of the related debt. The terms of
the transaction were determined by negotiation between the Company and LLCP.
Approximately $21.8 million related to Term B remains outstanding at December
31, 2002.
Also in March 2000, the Company's Board of Directors authorized the issuance of
103,500 shares of the Company's common stock to SFSC in conjunction with the
$1.5 million of promissory note issued by the Company to SFSC in August and
September 1999. The shares of common stock issued were valued at approximately
$155,000 were included in deferred interest expense, and are being amortized
over the life of the related debt.
During the first quarter of 2001, the Company purchased a total of $8,000,000 of
outstanding indebtedness held by LLCP and SFSC. The Company purchased and
retired $4,000,000 of subordinated debt held by SFSC in exchange for payment of
$3,920,000, and purchased and retired $4,000,000 of senior secured debt held by
LLCP in exchange for payment of $4,200,000. The LLCP debt by its terms called
for a prepayment penalty of 3% (or $120,000); the additional 2% (or $80,000)
paid in connection with its February 2001 prepayment was absorbed by SFSC.
In March 2002, the Company and LLCP entered into an additional series of
agreements under which LLCP provided additional funding to enable the Company to
acquire MFN Financial Corporation. Under the March 2002 agreements, the Company
borrowed $35 million from LLCP as a Bridge Note (Bridge Note) and approximately
$8.5 million ("Term C") on a deemed principal amount of approximately $11.2
million. The Bridge Note requires principal payments of $2.0 million a month,
which began in June 2002, with a final balloon payment in the amount of $17.0
million, which was made pursuant to the terms of the Bridge Note in February
2003. The Term C Note repayment schedule is based on the performance of a
certain securitized pool. As the subordinated Note of the pool is repaid from
the Trust, principal payments are due on the Term C Note. The maturity date of
the Term C Note is March 2008. Interest is due monthly on the Bridge Note at a
rate of 13.5% per annum and on the Term C Note at a rate of 12.0% per annum. In
connection with the March 2002 agreements and the acquisition of MFN, the
Company paid LLCP a structuring fee of $1.75 million and an investment banking
fee of $1.0 million, and paid LLCP's out-of-pocket expenses of approximately
$315,000. In addition, the Company paid LLCP certain other fees and interest
amounting to $426,181. Approximately $1.4 million of the fees and other amounts
paid to LLCP were deferred as financing costs and are being amortized over the
life of the related debt. The remaining fees and other costs were included in
the purchase price of MFN. At December 31, 2002, there was $21.0 million and
$7.3 million principal outstanding on the Bridge Note and Term C, respectively.
At the time of the Merger, MFN had outstanding $22.5 million in principal amount
of senior subordinated debt, which was due and repaid in full on March 23, 2002.
Such debt bore interest at the rate of 11.00% per annum, payable quarterly in
arrears.
LLCP holds approximately 22.2% of the Company's outstanding common shares. SFSC
is an affiliate of the Company's former Chairman, Charles E. Bradley, Sr., and
SFSC and Mr. Bradley, Sr. together hold approximately 14.6% of the Company's
outstanding common shares.
The Company must comply with certain affirmative and negative covenants related
to debt facilities, which require, among other things, that the Company maintain
certain financial ratios related to liquidity, net worth, capitalization,
investments, acquisitions, restricted payments and certain dividend
33
restrictions. The Company is in compliance with all of its debt covenants as of
December 31, 2002. Such covenants relate primarily to financial reporting
requirements, restricted payments and the Company's debt coverage ratio as
defined in the various debt agreements.
In July 2000, the Board of Directors authorized the purchase of up to $5,000,000
of outstanding debt and equity securities of the Company, inclusive of the
mandatory annual purchase or redemption of $1,000,000 of the Company's
outstanding "RISRS" subordinated debt securities, due 2006. In October 2002, the
Board of Directors authorized the purchase of an additional $5,000,000 of
outstanding debt or equity securities. As of December 31, 2002, the Company had
purchased $3.0 million in principal amount of the RISRS, and $2.6 million of its
common stock, representing 1,592,611 shares.
FORWARD-LOOKING STATEMENTS
This report on Form 10-K includes certain "forward-looking statements,"
including, without limitation, the statements or implications to the effect that
(i) gross losses as a percentage of original balances will approximate 13% to
18% cumulatively over the lives of the related Contracts, with recovery rates
approximating 2% to 5% of original principal balances, (ii) that the Company
believes it will achieve operating expense savings or synergies in connection
with the Merger, and (iii) that management anticipates that the Company will
earn taxable income during the current year. Other forward-looking statements
may be identified by the use of words such as "anticipates," "expects," "plans,"
"estimates," or words of like meaning. As to the specifically identified
forward-looking statements, factors that could affect gross losses and recovery
rates include changes in the general economic climate, which could affect the
willingness or ability of obligors to pay pursuant to the terms of Contracts,
changes in laws respecting consumer finance, which could affect the ability of
the Company to enforce rights under Contracts, and changes in the market for
used vehicles, which could affect the levels of recoveries upon sale of
repossessed vehicles. Factors that could affect operating expense savings
include the ability of Company staff to perform tasks previously performed by
others, and the real estate markets in regions in which the Company may close
facilities. Factors that could affect the Company's revenues in the current year
include the levels of cash releases from existing pools of Contracts, which
would affect the Company's ability to purchase Contracts, the terms on which the
Company is able to finance such purchases, the willingness of Dealers to sell
Contracts to the Company on the terms that it offers, and the terms on which the
Company is able to sell Contracts once acquired. Factors that could affect the
Company's expenses in the current year include those that affect its ability to
achieve expense savings, identified above, competitive conditions in the market
for qualified personnel, and interest rates (which affect the rates that the
Company pays on Notes issued in its securitizations).
Additional risk factors, any of which could have a material effect on the
Company's performance, are set forth below:
DEPENDENCE ON WAREHOUSE FINANCING. The Company's primary source of day-to-day
liquidity is continuous securitization of Contracts, under which it sells
Contracts to a special-purpose subsidiary as often as once a week. Such
transactions function as a "warehouse," in which Contracts are held pending
their future sale into a term securitization. The Company expects to continue to
effect similar transactions (or to obtain replacement or additional financing)
as current arrangements expire or become fully utilized; however, there can be
no assurance that such financing will be obtainable on favorable terms. To the
extent that the Company is unable to maintain its existing structure or is
unable to arrange new warehouse facilities, the Company may have to curtail
Contract purchasing activities, which could have a material adverse effect on
the Company's financial condition and results of operations.
DEPENDENCE ON SECURITIZATION PROGRAM. The Company is dependent upon its ability
to continue to pool and sell Contracts in term securitizations in order to
generate cash proceeds for new purchases. Adverse changes in the market for
securitized Contract pools, or a substantial lengthening of the warehousing
period, would burden the Company's financing capabilities, could require the
Company to curtail its purchase of Contracts, and could have a material adverse
34
effect on the Company. In addition, as a means of reducing the percentage of
cash collateral that the Company would otherwise be required to deposit and
maintain in Spread Accounts, all of the Company's securitizations since June
1994 have utilized credit enhancement in the form of financial guaranty
insurance policies issued by monoline financial guaranty insurers. The Company
believes that financial guaranty insurance policies reduce the costs of
securitizations relative to alternative forms of credit enhancements available
to the Company. No insurer is required to insure Company-sponsored
securitizations and there can be no assurance that any will continue to do so.
Similarly, there can be no assurance that any securitization transaction will be
available on terms acceptable to the Company, or at all. The timing of any
securitization transaction is affected by a number of factors beyond the
Company's control, any of which could cause substantial delays, including,
without limitation, market conditions and the approval by all parties of the
terms of the securitization.
RISK OF GENERAL ECONOMIC DOWNTURN. The Company's business is directly related to
sales of new and used automobiles, which are affected by employment rates,
prevailing interest rates and other domestic economic conditions. Delinquencies,
foreclosures and losses generally increase during economic slowdowns or
recessions. Because of the Company's focus on Sub-Prime Customers, the actual
rates of delinquencies, repossessions and losses on such Contracts could be
higher under adverse economic conditions than those experienced in the
automobile finance industry in general. Any sustained period of economic
slowdown or recession could adversely affect the Company's ability to sell or
securitize pools of Contracts. The timing of any economic changes is uncertain,
and sluggish sales of automobiles and weakness in the economy could have an
adverse effect on the Company's business and that of the Dealers from which it
purchases Contracts.
DEPENDENCE ON PERFORMANCE OF SOLD CONTRACTS. Under the financial structures the
Company has used to date in its term securitizations, certain excess servicing
cash flows generated by the Contracts sold in the term securitizations are
retained in a Spread Account within the securitization trusts to provide
liquidity and credit enhancement. While the specific terms and mechanics of the
Spread Account vary among transactions, the Company's Securitization Agreements
generally provide that the Company will receive excess cash flows only if the
Spread Account balances have reached specified levels and/or the delinquency or
losses related to the Contracts in the pool are below certain predetermined
levels. In the event delinquencies and losses on the Contracts exceed such
levels, the terms of the securitization may require increased Spread Account
balances to be accumulated for the particular pool; may restrict the
distribution to the Company of excess cash flows associated with other pools;
or, in certain circumstances, may permit the insurers to require the transfer of
servicing on some or all of the Contracts to another servicer. Any of these
conditions could materially adversely affect the Company's liquidity and
financial condition.
CREDITWORTHINESS OF CONSUMERS. The Company specializes in the purchase, sale and
servicing of Contracts to finance automobile purchases by Sub-Prime Customers,
which entail a higher risk of non-performance, higher delinquencies and higher
losses than Contracts with more creditworthy customers. While the Company
believes that the underwriting criteria and collection methods it employs enable
it to control the higher risks inherent in Contracts with Sub-Prime Customers,
no assurance can be given that such criteria and methods will afford adequate
protection against such risks. The Company has experienced fluctuations in the
delinquency and charge-off performance of its Contracts. In the event that
portfolios of Contracts sold and serviced by the Company experience greater
defaults, higher delinquencies or higher losses than anticipated, the Company's
income could be negatively affected. A larger number of defaults than
anticipated could also result in adverse changes in the structure of the
Company's future securitization transactions, such as a requirement of increased
cash collateral in such transactions.
POSSIBLE INCREASE IN COST OF FUNDS. The Company's profitability is determined
by, among other things, the difference between the rate of interest charged on
the Contracts purchased by the Company and the rate of interest payable to
purchasers of Notes issued in securitizations. The Contracts purchased by the
Company generally bear finance charges close to or at the maximum permitted by
35
applicable state law. The interest rates payable on such Notes the Company are
fixed, based on interest rates prevailing in the market at the time of sale.
Consequently, increases in market interest rates tend to reduce the "spread" or
margin between Contract finance charges and the interest rates required by
investors and, thus, the potential operating profits to the Company from the
purchase, sale and servicing of Contracts. Operating profits expected to be
earned by the Company on portfolios of Contracts previously sold are insulated
from the adverse effects of increasing interest rates because the interest rates
on the related Notes were fixed at the time the Contracts were sold. Any future
increases in interest rates would likely increase the interest rates on Notes
issued in future term securitizations and could have a material adverse effect
on the Company's results of operations.
PREPAYMENT AND DEFAULT RISK. Gains from the sale of Contracts in the Company's
past securitization transactions have constituted a significant portion of the
net income of the Company and are likely to continue to represent a significant
portion of the Company's net income. A portion of the gains is based in part on
management's estimates of future prepayment and default rates and other
considerations in light of then-current conditions. If actual prepayments with
respect to Contracts occur more quickly than was projected at the time such
Contracts were sold, as can occur when interest rates decline, or if default
rates are greater than projected at the time such Contracts were sold, a charge
to income may be required and would be taken in the period of adjustment. If
actual prepayments occur more slowly or if default rates are lower than
estimated with respect to Contracts sold, total revenue would exceed previously
estimated amounts.
COMPETITION. The automobile financing business is highly competitive. The
Company competes with a number of national, local and regional finance
companies. In addition, competitors or potential competitors include other types
of financial services companies, such as commercial banks, savings and loan
associations, leasing companies, credit unions providing retail loan financing
and lease financing for new and used vehicles and captive finance companies
affiliated with major automobile manufacturers such as General Motors Acceptance
Corporation, Ford Motor Credit Corporation, Chrysler Financial Corporation and
Nissan Motors Acceptance Corporation. Many of the Company's competitors and
potential competitors possess substantially greater financial, marketing,
technical, personnel and other resources than the Company. Moreover, the
Company's future profitability will be directly related to the availability and
cost of its capital relative to that of its competitors. The Company's
competitors and potential competitors include far larger, more established
companies that have access to capital markets for unsecured commercial paper and
investment grade rated debt instruments, and to other funding sources which may
be unavailable to the Company. Many of these companies also have long-standing
relationships with Dealers and may provide other financing to Dealers, including
floor plan financing for the Dealers' purchases of automobiles from
manufacturers, which is not offered by the Company. There can be no assurance
that the Company will be able to continue to compete successfully.
LITIGATION. Because of the consumer-oriented nature of the industry in which the
Company operates and the application of certain laws and regulations, industry
participants are regularly named as defendants in class-action litigation
involving alleged violations of federal and state laws and regulations and
consumer law torts, including fraud. Many of these actions involve alleged
violations of consumer protection laws. Although the Company is not involved in
any material litigation, a significant judgment against the Company or within
the industry in connection with any such litigation could have a material
adverse effect on the Company's financial condition and results of operations.
DEPENDENCE ON DEALERS. The Company is dependent upon establishing and
maintaining relationships with unaffiliated Dealers to supply it with Contracts.
During the year ended December 31, 2002, no Dealer accounted for more than 1.0%
of the Contracts purchased by the Company. The Dealer Agreements do not require
Dealers to submit a minimum number of Contracts for purchase by the Company. The
failure of Dealers to submit Contracts that meet the Company's underwriting
criteria would have a material adverse effect on the Company's financial
condition and results of operations.
36
GOVERNMENT REGULATIONS. The Company's business is subject to numerous federal
and state consumer protection laws and regulations, which, among other things:
(i) require the Company to obtain and maintain certain licenses and
qualifications; (ii) limit the interest rates, fees and other charges the
Company is allowed to charge; (iii) limit or prescribe certain other terms of
its Contracts; (iv) require the Company to provide specified disclosures; and
(v) regulate certain servicing and collection practices and define its rights to
repossess and sell collateral. An adverse change in existing laws or
regulations, or in the interpretation thereof, the promulgation of any
additional laws or regulations, or the failure to comply with such laws and
regulations could have a material adverse effect on the Company's financial
condition and results of operations.
NEW ACCOUNTING PRONOUNCEMENTS
The Company will adopt in future periods new accounting pronouncements. For
information on how adoption has affected and will affect the Financial
Statements, see Note 1 of Notes to Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
Although the Company utilized its floating rate variable note purchase facility
and completed term securitizations during the year ended December 31, 2002, the
structures did not lend themselves to some of the strategies the Company has
used in the past to minimize interest rate risk, as described below.
Specifically, the rate on the Notes issued by the floating rate variable note
purchase facility is adjustable and there is no pre-funding component to the
floating rate variable note purchase facility or term securitization. The
Company does intend to issue fixed rate Notes and to include pre-funding
structures for future term securitization transactions, whereby the amount of
asset-backed securities issued exceeds the amount of Contracts initially sold to
the Trusts. In pre-funding, the proceeds from the pre-funded portion are held in
an escrow account until the Company sells the additional Contracts to the Trust
in amounts up to the balance of the pre-funded escrow account. In pre-funded
securitizations, the Company locks in the borrowing costs with respect to the
Contracts it subsequently delivers to the Trust. However, the Company incurs an
expense in pre-funded securitizations equal to the difference between the money
market yields earned on the proceeds held in escrow prior to subsequent delivery
of Contracts and the interest rate paid on the asset-backed securities
outstanding, the amount as to which there can be no assurance. In addition, the
Contracts the Company does purchase and securitize have fixed rates of interest,
whereas the Company's interest expense related to the current note purchase
facility is based on a variable rate. Historically, the Company's term
securitization facilities had fixed rates of interest. Therefore, some of the
strategies the Company has used in the past to minimize interest rate risk do
not currently apply.
The Company is subject to market risks due to fluctuations in interest rates
primarily through its outstanding indebtedness and to a lesser extent its
outstanding interest earning assets, and commitments to enter into new
Contracts. The table below outlines the carrying values and estimated fair
values of such financial instruments:
37

Much of the information used to determine fair value is highly subjective. When
applicable, readily available market information has been utilized. However, for
a significant portion of the Company's financial instruments, active markets do
not exist. Therefore, considerable judgments were required in estimating fair
value for certain items. The subjective factors include, among other things, the
estimated timing and amount of cash flows, risk characteristics, credit quality
and interest rates, all of which are subject to change. Since the fair value is
estimated and do not reflect amounts of which amounts outstanding could be
settled by the Company, the amounts that will actually be realized or paid at
settlement or maturity of the instruments could be significantly different.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This report includes Consolidated Financial Statements, notes thereto and an
Independent Auditors' Report, at the pages indicated below. Certain unaudited
quarterly financial information is included in the Notes to Consolidated
Financial Statements, as Note 17.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
38
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
Information regarding directors of the registrant is incorporated by reference
to the registrant's definitive proxy statement for its annual meeting of
shareholders to be held in 2003 (the "2003 Proxy Statement"). The 2003 Proxy
Statement will be filed not later than April 30, 2003. Information regarding
executive officers of the registrant appears in Part I of this report, and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the 2003 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the 2003 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the 2003 Proxy Statement.
ITEM 14. CONTROLS AND PROCEDURES
QUARTERLY EVALUATION OF THE COMPANY'S DISCLOSURE CONTROLS AND INTERNAL CONTROLS
Within the 90 days prior to the date of this Annual Report on Form 10-K, the
Company evaluated the effectiveness of the design and operation of its
"disclosure controls and procedures" ("Disclosure Controls"), and its "internal
controls and procedures for financial reporting" ("Internal Controls"). This
evaluation (the Controls Evaluation) was performed under the supervision and
with the participation of management, including our Chief Executive Officer
("CEO") and Chief Financial Officer ("CFO").
CEO AND CFO CERTIFICATIONS
Immediately following the Signatures section of this Annual Report, there are
two separate forms of "Certifications" of the CEO and the CFO. The first form of
Certification (the Rule 13a-14 Certification) is required in accord with Rule
13a-14 of the Securities Exchange Act of 1934 (the "Exchange Act"). This
Controls and Procedures section of the Annual Report includes the information
concerning the Controls Evaluation referred to in the Rule 13a-14 Certifications
and it should be read in conjunction with the Rule 13a-14 Certifications for a
more complete understanding of the topics presented.
DISCLOSURE CONTROLS AND INTERNAL CONTROLS
Disclosure Controls are procedures designed to ensure that information required
to be disclosed in our reports filed under the Exchange Act, such as this Annual
Report, is recorded, processed, summarized and reported within the time periods
specified in the U.S. Securities and Exchange Commission's (the "SEC") rules
and forms. Disclosure Controls are also designed to ensure that such information
is accumulated and communicated to our management, including the CEO and CFO, as
appropriate to allow timely decisions regarding required disclosure. Internal
Controls are procedures designed to provide reasonable assurance that (1) our
transactions are properly authorized; (2) our assets are safeguarded against
unauthorized or improper use; and (3) our transactions are properly recorded and
reported, all to permit the preparation of our Consolidated Financial Statements
in conformity with accounting principles generally accepted in the United States
of America.
39
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS
The Company's management, including the CEO and CFO, does not expect that our
Disclosure Controls or our Internal Controls will prevent all error and all
fraud. A control system, no matter how well designed and operated, can provide
only reasonable, not absolute, assurance that the control system's objectives
will be met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Controls can also be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the controls. The design of any system of controls is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions. Over time, controls may become inadequate because of changes
in conditions or deterioration in the degree of compliance with its policies or
procedures. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
SCOPE OF THE CONTROLS EVALUATION
The evaluation of our Disclosure Controls and our Internal Controls included a
review of the controls' objectives and design, the Company's implementation of
the controls and the effect of the controls on the information generated for use
in this Annual Report. In the course of the Controls Evaluation, we sought to
identify data errors, controls problems or acts of fraud and confirm that
appropriate corrective actions, including process improvements, were being
undertaken. This type of evaluation is performed on a quarterly basis so that
the conclusions of management, including the CEO and CFO, concerning controls
effectiveness can be reported in our Quarterly Reports on Form 10-Q and Annual
Report on Form 10-K. Our Internal Controls are also evaluated by other personnel
in our organization, as well as independent interested third parties such as
financial guaranty insurers or their designees. The overall goals of these
various evaluation activities are to monitor our Disclosure Controls and our
Internal Controls, and to modify them as necessary; our intent is to maintain
the Disclosure Controls and the Internal Controls as dynamic systems that change
as conditions warrant.
Among other matters, we sought in our evaluation to determine whether there were
any "significant deficiencies" or "material weaknesses" in the Company's
Internal Controls, and whether the Company had identified any acts of fraud
involving personnel with a significant role in the Company's Internal Controls.
This information was important both for the Controls Evaluation generally, and
because items 5 and 6 in the Rule 13a-14 Certifications of the CEO and CFO
require that the CEO and CFO disclose that information to our Board's Audit
Committee and our independent auditors, and report on related matters in this
section of the Annual Report. In professional auditing literature, "significant
deficiencies" are referred to as "reportable conditions," which are control
issues that could have a significant adverse effect on the ability to record,
process, summarize and report financial data in the Consolidated Financial
Statements. Auditing literature defines "material weakness" as a particularly
serious reportable condition where the internal control does not reduce to a
relatively low level the risk that misstatements caused by error or fraud may
occur in amounts that would be material in relation to the Consolidated
Financial Statements and the risk that such misstatements would not be detected
40
within a timely period by employees in the normal course of performing their
assigned functions. We also sought to deal with other controls matters in the
Controls Evaluation, and in each case if a problem was identified, we considered
what revision, improvement and/or correction to make in accordance with our
ongoing procedures.
From the date of the Controls Evaluation to the date of this Annual Report,
there have been no significant changes in Internal Controls or in other factors
that could significantly affect Internal Controls, including any corrective
actions with regard to significant deficiencies and material weaknesses.
CONCLUSIONS
Based upon the Controls Evaluation, our CEO and CFO have concluded that, subject
to the limitations noted above, our Disclosure Controls are effective to ensure
that material information relating to Consumer Portfolio Services, Inc. and its
consolidated subsidiaries is made known to management, including the CEO and
CFO, particularly during the period when our periodic reports are being
prepared, and that our Internal Controls are effective to provide reasonable
assurance that our Consolidated Financial Statements are fairly presented in
conformity with accounting principles generally accepted in the United States of
America.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8K
(a) The financial statements listed above under the caption "Index to Financial
Statements" are filed as a part of this report. No financial statement schedules
are filed as the required information is inapplicable or the information is
presented in the Consolidated Financial Statements or the related notes.
Separate financial statements of the Company have been omitted as the Company is
primarily an operating company and its subsidiaries are wholly owned and do not
have minority equity interests and/or indebtedness to any person other than the
Company in amounts which together exceed 5% of the total consolidated assets as
shown by the most recent year-end Consolidated Balance Sheet.
The exhibits listed below are filed as part of this report, whether filed
herewith or incorporated by reference to an exhibit filed with the report
identified in the parentheses following the description of such exhibit. Unless
otherwise indicated, each such identified report was filed by or with respect to
the registrant.
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
2.1 Agreement and Plan of Merger, dated as of November 18, 2001,
by and among the Registrant, CPS Mergersub, Inc. and MFN
Financial Corporation. (Form 8-K filed on November 19, 2001 by
MFN Financial Corporation).
3.1 Restated Articles of Incorporation (Form 10-KSB dated December
31, 1995)
3.2 Amended and Restated Bylaws (Form 10-K dated December 31,
1997)
4.1 Indenture re Rising Interest Subordinated Redeemable
Securities ("RISRS") (Form 8-K filed December 26, 1995)
4.2 First Supplemental Indenture re RISRS (Form 8-K filed December
26, 1995)
41
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
4.3 Form of Indenture re 10.50% Participating Equity Notes
("PENs") (Form S-3, no. 333-21289)
4.4 Form of First Supplemental Indenture re PENs (Form S-3, no.
333-21289)
4.5 Second Amended and Restated Securities Purchase Agreement,
dated as of March 8, 2002, by and between Levine Leichtman
Capital Partners II, L.P. and the Registrant. (Form 8-K filed
on March 25, 2002).
4.5a First Amendment to the Second Amended and Restated Securities
Purchase Agreement dated as of March 8, 2002. (Schedule 13D
filed with respect to the Company on February 11, 2003).
4.5b Second Amendment to the Second Amended and Restated Securities
Purchase Agreement dated as of March 8, 2002. (Schedule 13D
filed with respect to the Company on February 11, 2003).
4.6 Secured Senior Note due February 28, 2003 issued by the
Registrant to Levine Leichtman Capital Partners II, L.P. (Form
8-K filed on March 25, 2002).
4.7 Second Amended and Restated Secured Senior Note due November
30, 2003 issued by the Registrant to Levine Leichtman Capital
Partners II, L.P. (Form 8-K filed on March 25, 2002).
4.8 12.00% Secured Senior Note due 2008 issued by the Registrant
to Levine Leichtman Capital Partners II, L.P. (Form 8-K filed
on March 25, 2002).
4.8.1 Secured Senior Note dated February 3, 2003, issued by the
Registrant to Levine Leichtman Capital Partners II, L.P.
(Schedule 13D filed with respect to the Company on February
11, 2003).
4.9 Sale and Servicing Agreement, dated as of March 1, 2002, among
the Registrant, CPS Auto Receivables Trust 2002-A, CPS
Receivables Corp., Systems & Services Technologies, Inc. and
Bank One Trust Company, N.A. (Form 8-K filed on March 25,
2002).
4.10 Indenture, dated as of March 1, 2002, between CPS Auto
Receivables Trust 2002-A and Bank One Trust Company, N.A.
(Form 8-K filed on March 25, 2002).
10.1 1991 Stock Option Plan & forms of Option Agreements thereunder
(Form 10-KSB dated March 31, 1994)
10.2 1997 Long-Term Incentive Stock Plan (Form 10-K filed March
10, 1998)
10.3 Lease Agreement re Chesapeake Collection Facility (Form 10-K
dated December 31, 1996)
10.4 Lease of Headquarters Building (Form 10-Q dated September 30,
1997)
10.5 Partially Convertible Subordinated Note (Form 10-Q dated
September 30, 1997)
10.13 FSA Warrant Agreement dated November 30, 1998 (Form 10-K dated
December 31, 1998)
10.29 Warrant to Purchase 1,335,000 Shares of Common Stock (Schedule
13D filed on April 21, 1999)
10.32 Amendment to Master Spread Account Agreement (Form 10-K dated
December 31, 1999)
23.1 Consent of independent auditors (filed herewith)
Reports on Form 8-K
The Company did not file any reports on Form 8-K during the fourth quarter of
the year ended December 31, 2002.
42
SIGNATURES AND CERTIFICATIONS OF THE CHIEF EXECUTIVE OFFICER AND THE CHIEF
FINANCIAL OFFICER
The following pages include the Signatures page for this Form 10-K, and two
separate Certifications of the Chief Executive Officer ("CEO") and the Chief
Financial Officer ("CFO") of the company.
The first form of Certification is required by Rule 13a-14 (the Rule 13a-14
Certification) under the Securities Exchange Act of 1934 (the "Exchange Act").
The Rule 13a-14 Certification includes references to an evaluation of the
effectiveness of the design and operation of the company's "disclosure controls
and procedures" and its "internal controls and procedures for financial
reporting." Item 14 of Part III of this Annual Report presents the conclusions
of the CEO and the CFO about the effectiveness of such controls based on and as
of the date of such evaluation (relating to Item 4 of the Rule 13a-14
Certification), and contains additional information concerning disclosures to
the company's Audit Committee and independent auditors with regard to
deficiencies in internal controls and fraud (Item 5 of the Rule 13a-14
Certification) and related matters (Item 6 of the Rule 13a-14 Certification).
The second form of Certification is required by section 1350 of chapter 63 of
title 18 of the United States Code.
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
CONSUMER PORTFOLIO SERVICES, INC. (REGISTRANT)
March 26, 2003 By: /s/ Charles E. Bradley, Jr.
-------------------------------------------
Charles E. Bradley, Jr., PRESIDENT
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
March 26, 2003 /s/ Charles E. Bradley, Jr.
--------------------------------------------
Charles E. Bradley, Jr., DIRECTOR,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
March 26, 2003 /s/ Thomas L. Chrystie
--------------------------------------------
Thomas L. Chrystie, DIRECTOR
March 26, 2003 /s/ E. Bruce Fredrikson
--------------------------------------------
E. Bruce Fredrikson, DIRECTOR
March 26, 2003 /s/ John E. McConnaughy, Jr.
--------------------------------------------
John E. McConnaughy, Jr., DIRECTOR
March 26, 2003 /s/ John G. Poole
--------------------------------------------
John G. Poole, DIRECTOR
March 26, 2003 /s/ William B. Roberts
--------------------------------------------
William B. Roberts, DIRECTOR
March 26, 2003 /s/ Daniel S. Wood
--------------------------------------------
Daniel S. Wood, DIRECTOR
March 26, 2003 /s/ David N. Kenneally
--------------------------------------------
David N. Kenneally, CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)
44
CERTIFICATION
I, Charles E. Bradley, Jr., certify that:
1. I have reviewed this annual report on Form 10-K of Consumer Portfolio
Services, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
March 26, 2003 By: /s/ Charles E. Bradley, Jr.
--------------------------------------
Charles E. Bradley, Jr.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
45
CERTIFICATION
I, David N. Kenneally, certify that:
1. I have reviewed this annual report on Form 10-K of Consumer Portfolio
Services, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
March 26, 2003 By: /s/ David N. Kenneally
-------------------------------------------
David N. Kenneally, CHIEF FINANCIAL OFFICER
46
CERTIFICATION
Each of the undersigned hereby certifies, for the purposes of section 1350 of
chapter 63 of title 18 of the United States Code, in his capacity as an officer
of Consumer Portfolio Services, Inc., that, to his knowledge, the Annual Report
of Consumer Portfolio Services, Inc. on Form 10-K for the period ended December
31, 2002, fully complies with the requirements of Section 13(a) of the
Securities Exchange Act of 1934 and that the information contained in such
report fairly presents, in all material respects, the financial condition and
results of operations of Consumer Portfolio Services, Inc.
March 26, 2003 By: /s/ Charles E. Bradley, Jr.
---------------------------------------------
Charles E. Bradley, Jr.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
March 26, 2003 By: /s/ David N. Kenneally
---------------------------------------------
David N. Kenneally, CHIEF FINANCIAL OFFICER
47

INDEX TO FINANCIAL STATEMENTS
PAGE
REFERENCE
---------
Independent Auditors' Report ........................................................................ F-2
Consolidated Balance Sheets as of December 31, 2002 and 2001 ........................................ F-3
Consolidated Statements of Operations for the years ended December 31, 2002, 2001, and 2000 ......... F-4
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2002, 2001,
and 2000 ........................................................................................ F-5
Consolidated Statements of Shareholders' Equity for the years ended December 31, 2002, 2001, and 2000 F-6
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000 ......... F-7
Notes to Consolidated Financial Statements for the years ended December 31, 2002, 2001, and 2000 .... F-9

F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Consumer Portfolio Services, Inc.:
We have audited the accompanying consolidated balance sheets of Consumer
Portfolio Services, Inc. and subsidiaries (the "Company") as of December 31,
2002 and 2001, and the related consolidated statements of operations,
comprehensive income (loss), shareholders' equity, and cash flows for each of
the years in the three-year period ended December 31, 2002. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Consumer Portfolio
Services, Inc. and subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America.
/s/ KPMG LLP
- ---------------------------
Orange County, California
February 26, 2003, except as to the last paragraph of note 18,
which is as of March 6, 2003
F-2

See accompanying Notes to Consolidated Financial Statements.
F-8
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Consumer Portfolio Services, Inc. ("CPS") was incorporated in California on
March 8, 1991. CPS and its subsidiaries (collectively, the "Company") engage
primarily in the business of purchasing, selling and servicing retail automobile
installment sale contracts ("Contracts") originated by licensed motor vehicle
dealers ("Dealers") located throughout the United States. The Company
specializes in Contracts with obligors who generally would not be expected to
qualify for traditional financing, such as that provided by commercial banks or
automobile manufacturers' captive finance companies.
MFN FINANCIAL CORPORATION ACQUISITION
On March 8, 2002, CPS acquired 100% of MFN Financial Corporation, a Delaware
corporation ("MFN") and its subsidiaries, by the merger (the "Merger") of CPS
Mergersub, Inc., a Delaware corporation ("Mergersub") and a direct wholly owned
subsidiary of CPS, with and into MFN. The Merger took place pursuant to an
Agreement and Plan of Merger, dated November 18, 2001 (the "Merger Agreement"),
among CPS, Mergersub and MFN. In the Merger, MFN became a wholly owned
subsidiary of CPS. CPS thus acquired the assets of MFN, consisting principally
of interests in automobile installment sales finance Contracts and the
facilities for originating and servicing such Contracts. The Merger was
accounted for as a purchase.
PRINCIPLES OF CONSOLIDATION
The Consolidated Financial Statements include the accounts of Consumer Portfolio
Services, Inc. and its wholly owned subsidiaries, certain of which are special
purpose subsidiaries ("SPS"), formed to accommodate the structures under which
the Company purchases and sells its Contracts. The Consolidated Financial
Statements also include the accounts of CPS Leasing, Inc., an 80% owned
subsidiary. All significant intercompany balances and transactions have been
eliminated in consolidation.
FINANCE RECEIVABLES, NET OF UNEARNED INCOME
Finance receivable Contracts held to maturity are presented at cost. Finance
receivable contracts include automobile installment sales contracts on which
interest is pre-computed and added to the amount financed. The interest on such
Contracts is included in unearned finance charges. Unearned finance charges are
amortized using the interest method over the remaining period to contractual
maturity. Generally, payments received on Contracts held to maturity are
restricted to certain securitized pools, and the related Contracts cannot be
resold. Finance receivables are charged off pursuant to the controlling
documents of certain securitized pools, generally before they become
contractually delinquent five payments. Contracts that are deemed uncollectible
prior to the maximum charge off period are charged off immediately. Management
may authorize a temporary extension of payment terms if collection appears
likely during the next calendar month.
F-9
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
ALLOWANCE FOR FINANCE CREDIT LOSSES
The Company utilizes a loss reserving methodology commonly referred to as
"static pooling," which stratifies its finance receivable portfolio into
separately identified pools. Using analytical and formula driven techniques, the
Company estimates an allowance for finance credit losses, which management
believes is adequate for known and inherent losses in the finance receivable
Contract portfolio. Provision for loss is charged to the Company's Consolidated
Statement of Operations. Charge offs are charged to the allowance. Management
evaluates the adequacy of the allowance by examining current delinquencies, the
characteristics of the portfolio and the value of the underlying collateral.
CONTRACT ACQUISITION FEES
Upon purchase of a Contract from a Dealer, the Company generally charges or
advances the Dealer an acquisition fee. The acquisition fees associated with
Contract purchases are deferred until the Contracts are sold, at which time the
deferred acquisition fees are recognized as a component of the gain on sale. The
Company also charged the purchaser an origination fee for those Contracts that
were sold on a flow basis. Those fees were recognized at the time the Contracts
were sold and were also a component of the gain on sale.
FLOW PURCHASE PROGRAM
Through May 2002, the Company purchased Contracts for immediate and outright
resale to non-affiliated third parties. The Company sold such Contracts for a
mark-up above what the Company paid the Dealer. In such sales, the Company made
certain representations and warranties to the purchasers, normal in the
industry, which related primarily to the legality of the sale of the underlying
motor vehicle and to the validity of the security interest being conveyed to the
purchaser. Those representations and warranties were generally similar to the
representations and warranties given by the originating Dealer to the Company.
In the event of a breach of such representations or warranties, the Company may
incur liabilities in favor of the purchaser(s) of the Contracts and there can be
no assurance that the Company would be able to recover, in turn, against the
originating Dealer(s).
RESIDUAL INTEREST IN SECURITIZATIONS AND GAIN ON SALE OF CONTRACTS
Gain on sale may be recognized on the disposition of Contracts outright or in
securitization transactions. In its securitization transactions, a wholly owned
subsidiary of the Company retains a residual interest in the Contracts that are
sold. The Company's securitization transactions include "term" securitizations
(purchaser holds the Contracts for substantially their entire term) and
"continuous" securitizations (the Contracts sold may be put back to the Company,
and subsequently replaced with other Contracts).
The residual interest in term securitizations and the residual interest in the
Contracts sold continuously are reflected in the line item "residual interest in
securitizations" on the Company's Consolidated Balance Sheet.
The Company's securitization structure has generally been as follows:
The Company sells a portfolio of Contracts to a wholly owned Special Purpose
Subsidiary ("SPS"), which has been established for the limited purpose of buying
and reselling the Company's Contracts. The SPS then transfers the same Contracts
to an owner trust ("Trust"). The Trust is a qualifying special purpose entity as
defined in Statement of Financial Accounting Standards No. 140 ("SFAS 140"), and
F-10
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
is therefore not consolidated in the Company's Consolidated Financial
Statements. The Trust issues interest-bearing asset-backed securities (the
"Notes"), generally in a principal amount equal to the aggregate principal
balance of the Contracts. The Company typically sells these Contracts to the
Trust at face value and without recourse, except that representations and
warranties similar to those provided by the Dealer to the Company are provided
by the Company to the Trust. One or more investors purchase the Notes issued by
the Trust; the proceeds from the sale of the Notes are then used to purchase the
Contracts from the Company. The Company may retain subordinated Notes issued by
the Trust. The Company purchases a financial guaranty insurance policy,
guaranteeing timely payment of principal and interest on the senior Notes, from
an insurance company (the "Note Insurers"). In addition, the Company provides a
credit enhancement for the benefit of the Note Insurers and the investors in the
form of an initial cash deposit to an account ("Spread Account") held by the
Trust or in the form of subordinated Notes, or both. The agreements governing
the securitization transactions (collectively referred to as the "Securitization
Agreements") require that the initial deposits to the Spread Accounts be
supplemented by a portion of collections from the Contracts until the Spread
Accounts reach specified levels, and then maintained at those levels. The
specified levels are generally computed as a percentage of the principal amount
remaining unpaid under the related Notes. The specified levels at which the
Spread Accounts are to be maintained will vary depending on the performance of
the portfolios of Contracts held by the Trusts and on other conditions, and may
also be varied by agreement among the Company, the SPS, the Note Insurers and
the trustee. Such levels have increased and decreased from time to time based on
performance of the portfolios, and have also varied by Securitization Agreement.
The Securitization Agreements generally grant the Company the option to
repurchase the sold Contracts from the Trust when the aggregate outstanding
balance has amortized to 10% or less of the initial aggregate balance.
The Company's continuous securitization structure is similar to the above,
except that (i) the SPS that purchases the Contracts pledges the Contracts to
secure promissory notes issued directly by the SPS, (ii) the initial purchaser
of such notes has the right, but not the obligation, to require that the Company
repurchase the Contracts, (iii) the promissory notes are in an aggregate
principal amount of not more than 72.5% to 73% of the aggregate principal
balance of the Contracts (that is, up to 27.5% over-collateralization), and (iv)
no Spread Account is involved. The SPS is a qualifying special purpose entity
and is therefore not consolidated in the Company's Consolidated Financial
Statements.
Upon each sale of Contracts in a securitization, whether a term securitization
or a continuous securitization, the Company removes from its Consolidated
Balance Sheet the Contracts held for sale and adds to its Consolidated Balance
Sheet (i) the cash received and (ii) the estimated fair value of the ownership
interest that the Company retains in Contracts sold in the securitization. That
retained interest (the "Residual") consists of (a) the cash held in the Spread
Account, if any, (b) over collateralization, if any, (c) subordinated Notes
retained, if any, and (d) receivables from Trust, which include the net interest
receivables ("NIRs"). NIRs represent the estimated discounted cash flows to be
received from the Trust in the future, net of principal and interest payable
with respect to the Notes, and certain expenses. The excess of the cash received
and the assets retained by the Company over the carrying value of the Contracts
sold, less transaction costs, equals the net gain on sale of Contracts recorded
by the Company.
The Company allocates its basis in the Contracts between the Notes and the
Residuals sold and retained based on the relative fair values of those portions
on the date of the sale. The Company recognizes gains or losses attributable to
the change in the fair value of the Residuals, which are recorded at estimated
fair value. The Company is not aware of an active market for the purchase or
sale of interests such as the Residuals; accordingly, the Company determines the
estimated fair value of the Residuals by discounting the amount and timing of
anticipated cash flows that it estimates will be released to the Company in the
future (the cash out method), using a discount rate that the Company believes is
appropriate for the risks involved. The Company estimates the value of its
F-11
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
optional right to repurchase receivables pursuant to the terms of the
Securitization Agreements primarily based on its estimate of the amount and
timing of cash flows that it anticipates will be received from the repurchased
receivables following exercise of the optional right. The anticipated cash flows
include collections from both current and charged off receivables. The Company
has used an effective discount rate of approximately 14% per annum, which it
believes is appropriate for the risks involved.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Residuals that represent collections on the Contracts in excess
of the amounts required to pay principal and interest on the Notes, the base
servicing fees, and certain other fees (such as trustee and custodial fees).
Required principal payments are in most cases defined as the payments sufficient
to keep the principal balance of the Notes equal to the aggregate principal
balance of the related Contracts (excluding those Contracts that have been
charged off). Some of the Securitization Agreements require accelerated payment
of principal until the principal balance of the Notes is reduced to a specified
percentage of the aggregate principal balance of the related Contracts. Such
accelerated principal payment is said to create "over-collateralization" of the
Notes.
If the amount of cash required for payment of fees, interest and principal
exceeds the amount collected during the collection period, the shortfall is
drawn from the Spread Account, if any. If the cash collected during the period
exceeds the amount necessary for the above allocations, and there is no
shortfall in the related Spread Account, the excess is released to the Company,
or in certain cases is transferred to other Spread Accounts that may be below
their required levels. If the Spread Account balance is not at the required
credit enhancement level, then the excess cash collected is retained in the
Spread Account until the specified level is achieved. Although Spread Account
balances are held by the Trusts on behalf of the Company's SPS as the owner of
the Residuals, the cash in the Spread Accounts is restricted from use by the
Company. Cash held in the various Spread Accounts is invested in high quality,
liquid investment securities, as specified in the Securitization Agreements. The
interest rate payable on the Contracts is significantly greater than the
interest rate on the Notes. As a result, the Residuals described above are a
significant asset of the Company. In determining the value of the Residuals, the
Company must estimate the future rates of prepayments, delinquencies, defaults
and default loss severity, and the value of the Company's optional right to
repurchase receivables pursuant to the terms of the Securitization Agreements,
as all of these factors affect the amount and timing of the estimated cash
flows. The Company estimates prepayments by evaluating historical prepayment
performance of comparable Contracts. The Company has used prepayment estimates
of approximately 20% to 23% cumulatively over the lives of the related
Contracts. The Company estimates defaults and default loss severity using
available historical loss data for comparable Contracts and the specific
characteristics of the Contracts purchased by the Company. The Company estimates
recovery rates of previously charged off receivables using available historical
recovery data and projected future recovery levels. In valuing the Residuals,
the Company estimates that gross losses as a percentage of the original
principal balance will approximate 13% to 18% cumulatively over the lives of the
related Contracts, with recovery rates approximating 2% to 5% of the original
principal balance.
In future periods, the Company will recognize additional revenue from the
Residuals if the actual performance of the Contracts is better than the original
estimate, or the Company would increase the estimated fair value of the
Residuals. If the actual performance of the Contracts were worse than the
original estimate, then a downward adjustment to the carrying value of the
Residuals would be required.
The Noteholders and the related securitization Trusts have no recourse to the
Company for failure of the Contract obligors to make payments on a timely basis.
The Company's Residuals, however, are subordinate to the Notes until the
Noteholders are fully paid, and the Company is therefore at risk to that extent.
F-12
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SERVICING
The Company considers the servicing fee received to approximate adequate
compensation. As a result, no servicing asset or liability has been recognized.
Servicing fees are reported as income when earned. Servicing costs are charged
to expense as incurred. Servicing fees receivable represent fees earned but not
yet remitted to the Company by the trustee.
FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost net of accumulated depreciation. The
Company calculates depreciation using the straight-line method over the
estimated useful lives of the assets, which range from three to five years.
Assets held under capital leases and leasehold improvements are amortized over
the lesser of the estimated useful lives of the assets or the related lease
terms.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company accounts for long-lived assets in accordance with the provisions of
SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets." This
Statement requires that long-lived assets and certain identifiable intangibles
be reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
carrying amount or fair value less costs to sell.
INCOME (LOSS) PER SHARE
The following table illustrates the computation of basic and diluted income
(loss) per share:

Incremental shares of 1.1 million related to the conversion of subordinated debt
have been excluded from the calculation for the years ended December 31, 2002
and 2001, because the impact of assumed conversion of such subordinated debt is
anti-dilutive. Excluded from the diluted loss per share calculation for the year
ended December 31, 2000 were 1.7 million shares from outstanding options and
warrants and 2.4 million from incremental shares attributable to the conversion
of certain subordinated debt, as these securities are anti-dilutive.
F-13
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DEFERRAL AND AMORTIZATION OF DEBT ISSUANCE COSTS
Costs related to the issuance of debt are amortized on a straight-line basis
over the shorter of the actual or expected term of the related debt.
INCOME TAXES
The Company and its subsidiaries file a consolidated federal income and combined
state franchise tax returns. The Company utilizes the asset and liability method
of accounting for income taxes, under which deferred income taxes are recognized
for the future tax consequences attributable to the differences between the
financial statement values of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date. The Company has estimated a valuation
allowance against that portion of the deferred tax asset whose utilization in
future periods is not more than likely.
In determining the possible realization of deferred tax assets, future taxable
income from the following sources are considered: (a) the reversal of taxable
temporary differences, (b) future operations exclusive of reversing temporary
differences, and (c) tax planning strategies that, if necessary, would be
implemented to accelerate taxable income into periods in which operating losses
might otherwise expire.
PURCHASES OF COMPANY STOCK
The Company records purchases of its own common stock at cost.
STOCK OPTION PLAN
As permitted by Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS No. 123"), the Company accounts for
stock-based employee compensation plans in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations, whereby stock options are recorded at intrinsic value equal to
the excess of the share price over the exercise price at the date of grant. The
Company provides the pro forma net income (loss), pro forma income per share,
and stock based compensation plan disclosure requirements set forth in SFAS No.
123. The Company accounts for repriced options as variable awards.
The per share weighted-average fair value of stock options granted during the
years ended December 31, 2002, 2001 and 2000, was $1.39, $1.79, and $2.74,
respectively, at the date of grant. That fair value was computed using the
Black-Scholes option-pricing model with the following weighted average
assumptions:

Compensation cost has been recognized for certain stock options in the
Consolidated Financial Statements in accordance with APB Opinion No. 25. Had the
Company determined compensation cost based on the fair value at the grant date
for its stock options under Statement of Financial Accounting Standards No. 123
("SFAS 123"), "Accounting for Stock Based Compensation," the Company's net
income (loss) and income per share would have been reduced to the pro forma
amounts indicated below.
F-14
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Pro forma net income (loss) and income (loss) per share reflect only options
granted in the years ended December 31, 1996 to 2002. Therefore, the full effect
of calculating compensation cost for stock options under SFAS No. 123 is not
reflected in the pro forma amounts presented above, because compensation cost is
reflected over the options' vesting period and compensation cost for options
granted prior to 1996 is not considered.
SEGMENT REPORTING
Operations are managed and financial performance is evaluated on a Company-wide
basis by a chief decision maker. Accordingly, all of the Company's operations
are aggregated in one reportable operating segment.
NEW ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement on Financial Accounting Standards No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS 145"). This statement updates, clarifies and simplifies
existing accounting pronouncements. SFAS 145 rescinds Statement on Financial
Accounting Standards 4, which required all gains and losses from extinguishment
of debt to be aggregated and, if material, classified as an extraordinary item,
net of related income tax effect. As a result, the criteria in Accounting
Pronouncements Board Opinion 30 will now be used to classify those gains and
losses. Statement on Financial Accounting Standards 64 amended Statement on
Financial Accounting Standards 4, and is no longer necessary because Statement
on Financial Accounting Standards 4 has been rescinded. Statement on Financial
Accounting Standards 44 was issued to establish accounting requirements for the
effects of transition to the provisions of the Motor Carrier Act of 1980.
Because the transition has been completed, Statement on Financial Accounting
Standards 44 is no longer necessary. SFAS 145 amends Statement on Financial
Accounting Standards 13 to require that certain lease modifications that have
economic effects similar to sale-leaseback transactions be accounted for in the
same manner as sale-leaseback transactions. This amendment is consistent with
the FASB's goal of requiring similar accounting treatment for transactions that
have similar economic effects. The adoption of SFAS No. 145 is not expected to
have a material effect on the Company.
In July 2002, FASB issued SFAS No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities," addresses financial accounting and reporting for
costs associated with exit or disposal activities. SFAS 146 nullifies Emerging
Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring) ("Issue 94-3")." The principal difference
F-15
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
between SFAS 146 and Issue 94-3 relates to the recognition of a liability for a
cost associated with an exit or disposal activity. SFAS 146 requires that a
liability be recognized for those costs only when the liability is incurred,
that is, when it meets the definition of a liability in the FASB's conceptual
framework. In contrast, under Issue 94-3, a company recognized a liability for
an exit cost when it committed to an exit plan. SFAS 146 also establishes fair
value as the objective for initial measurement of liabilities related to exit or
disposal activities. The provisions of SFAS 146 are to be applied prospectively
to exit or disposal activities initiated after December 31, 2002. The adoption
of SFAS No. 146 did not have a material effect on the Company.
The FASB issued Statement of Financial Accounting Standards No. 148 "Accounting
for Stock-Based Compensation--Transition and Disclosure" amends FASB Statement
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") in December
2002. SFAS 148 is designed to provide alternative methods of transition for
enterprises that elect to change to the SFAS 123 fair value method of accounting
for stock-based employee compensation. SFAS 148 will permit two additional
transition methods for entities that adopt the preferable SFAS 123 fair value
method of accounting for stock-based employee compensation. Both of those
methods avoid the ramp-up effect arising from prospective application of the
fair value method under the existing transition provisions of SFAS 123. In
addition, under the provisions of SFAS 148, the original Statement 123
prospective method of transition for changes to the fair value method will no
longer be permitted in fiscal periods beginning after December 15, 2003.
SFAS 148 will also amend the disclosure requirements of SFAS 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The provisions of SFAS 148 are effective for
fiscal years ended after December 15, 2002. The adoption of SFAS No. 148 is not
expected to have a material effect on the Company.
In November 2002, the Financial Accounting Standards Board issued Interpretation
No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others ("FIN 45")." FIN 45
clarifies previously issued accounting guidance and disclosure requirements for
guarantees, expands the disclosures to be made by a guarantor in its financial
statements about its obligations under certain guarantees, and requires the
guarantor to recognize a liability for the fair value of an obligation assumed
under a guarantee.
In general, the FIN 45 applies to contracts or indemnification agreements that
contingently require the guarantor to make payments to the guaranteed party
based on specified changes in an underlying variable that is related to an
asset, liability, or equity security of the guaranteed party. Guarantee
contracts excluded from both the disclosure and recognition requirements of FIN
45 include, among others, guarantees relating to employee compensation, residual
value guarantees under capital lease arrangements, commercial letters of credit,
commitments to extend credit, subordinated interests in an SPE, and guarantees
of a company's own future performance. Other guarantees subject to the
disclosure requirements of FIN 45, but not to the recognition provisions,
include, among others, a guarantee accounted for as a derivative instrument
under SFAS No. 133, a parent's guarantee of debt owed to a third party by its
subsidiary or vice versa, and a guarantee which is based on performance but not
price. The adoption of FIN 45 did not have a material effect on the Company.
Financial Accounting Standards Board Interpretation 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), issued January 2003, requires a variable
interest entity to be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity's activities or
is entitled to receive a majority of the entity's residual returns or both.
Prior to FIN 46, a company included another entity in its Consolidated Financial
Statements only if it controlled the entity through voting interests. FIN 46
also requires disclosures about variable interest entities that the company is
not required to consolidate but in which it has a significant variable interest.
The
F-16
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
consolidated requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003. The consolidated requirements apply to
older entities in the first fiscal year or interim period after June 15, 2003.
Certain disclosure requirements apply in all financial statements issued after
January 31, 2003, regardless of when the variable interest entity was
established. The adoption of FIN 46 is not expected to have a material effect on
the Company.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the financial statements, as well as the reported
amounts of income and expenses during the reported periods. Specifically, a
number of estimates were made in connection with determining an appropriate
allowance for finance credit losses, valuing the Residuals and computing the
related gain on sale on the transactions that created the Residuals, and
deferred tax asset valuation allowance. Actual results could differ from those
estimates depending on the future performance of the related Contracts.
RECLASSIFICATION
Certain amounts for the prior years have been reclassified to conform to the
current year's presentation.
(2) MFN FINANCIAL CORPORATION ACQUISITION
MFN, through its primary operating subsidiary, Mercury Finance Company LLC, was
in the business of purchasing automobile installment sales finance Contracts
from Dealers, and securitizing and servicing such Contracts. CPS intends to
continue to use the assets acquired in the Merger in the automobile finance
business, but a portion of such assets have been disposed of. CPS has ceased to
use the acquired assets for the purchase of automobile installment sales finance
Contracts, and does not anticipate recommencing such use. In connection with the
termination of MFN origination activities and the integration and consolidation
of certain activities, the Company has recognized certain liabilities related to
the costs to exit these activities and terminate the affected employees of MFN.
These activities include service departments such as accounting, finance, human
resources, information technology, administration, payroll and executive
management. These costs include the following:

- ------------
(1) Activity resulting in a net charge $157,000 includes charges against
liability of $1.4 million, and the "reclassification" of an existing accrual for
offices closed prior to the Merger Date of approximately $1.2 million.
(2) Approximately $2.9 million of remaining accrual is recorded in the
Consolidated Balance Sheet of the Company at December 31, 2002. The Company
believes that this amount provides adequately for anticipated remaining costs
related to exiting certain activities of MFN, and that amounts indicated above
are reasonably allocated.
F-17
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Upon effectiveness of the Merger, each outstanding share of common stock of MFN
converted into the right to receive $10.00 per share in cash. The total Merger
consideration payable to stockholders of MFN was approximately $99.9 million.
The amount of such consideration was agreed to as the result of arms'-length
negotiations between CPS and MFN. The aggregate purchase price, including
expenses related to the transaction, was approximately $123.2 million.
Acquisition financing was provided to CPS by Westdeutsche Landesbank
Girozentrale, New York Branch ("WestLB") and Levine Leichtman Capital Partners
II, L.P ("LLCP"). CPS obtained acquisition financing from LLCP through its
issuance and sale of certain senior secured notes to LLCP in the aggregate
principal amount of $35 million.
The Company's Consolidated Balance Sheet and Consolidated Statement of
Operations as of and for the year ended December 31, 2002 include the results of
operations of MFN for the period subsequent to March 8, 2002, the Merger date.
The Company has recorded certain purchase accounting adjustments recorded on its
Consolidated Balance Sheet, which are estimates based on available information.
In addition, the Company's Consolidated Statement of Operations for the year
ended December 31, 2002 includes an extraordinary gain related to the excess of
net assets acquired over purchase price ("negative goodwill") totaling $17.4
million.
The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed at the date of acquisition.
MARCH 8, 2002
-------------
(IN THOUSANDS)
Cash ........................................................... $ 93,782
Restricted cash ................................................ 25,499
Finance Contracts, net ......................................... 186,554
Residual interest in securitizations ........................... 32,485
Other assets ................................................... 12,006
---------
Total assets acquired .................................. 350,326
---------
Securitization trust debt ...................................... 156,923
Subordinated debt .............................................. 22,500
Accounts payable and other liabilities ......................... 30,242
---------
Total liabilities assumed .............................. 209,665
---------
Net assets acquired .................................... 140,661
Less: purchase price ................................... 123,249
---------
Excess of net assets acquired over purchase price ...... $ 17,412
=========
The unaudited pro forma combined results of operations presented below do not
reflect future events that may occur after the Merger. The Company believes that
operating expense savings between Consumer Portfolio Services, Inc. and MFN will
be realized after the Merger. However, for purposes of unaudited pro forma
combined results of operations presented below, such savings have not been
reflected.
Selected unaudited pro forma combined results of operations for the years ended
December 31, 2002 and 2001, assuming the Merger occurred on January 1, 2002 and
2001, are as follows:
F-18
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(3) RESTRICTED CASH
Restricted cash comprised the following components:
DECEMBER 31,
-------------------------
2002 2001
-------- --------
(IN THOUSANDS)
Securitization trust accounts .............. $11,881 $ --
Flow purchases deposit ..................... -- 4,100
Litigation reserve ......................... 5,503 3,303
Note purchase facility reserve ............. 968 3,060
Lockbox agreement deposit .................. -- 500
Other ...................................... 560 391
-------- --------
Total restricted cash ................... $18,912 $11,354
======== ========
Certain of the Company's operating agreements require that the Company establish
cash reserves for the benefit of the other parties to the agreements, in case
those parties are subject to any claims or exposure. In addition, certain of
these agreements require that the Company establish amounts in reserve related
to outstanding litigation. As of the date of this report, the lockbox agreement
has been terminated and the note purchase facility has been repaid, and the
related cash is no longer restricted. No other amounts have been drawn from the
remaining accounts.
During 2000, the Company established agreements with third parties that purchase
Contracts from the Company on a flow through basis, to expedite payment for
Contracts that the Company sells to such purchasers. As part of the agreements,
the Company agreed to post cash reserves to be used to pay for any Contracts not
ultimately accepted by the respective third parties. Such agreements were
terminated in conjunction with the termination of the flow purchase program.
F-19
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(4) FINANCE RECEIVABLES
The following table presents the components of Finance Receivables, net of
unearned interest:
DECEMBER 31, 2002
-----------------
(IN THOUSANDS)
Finance Receivables
Automobile
Simple interest ............................................ $ 31,359
Pre-compute or "Rule of 78's", net of unearned interest ..... 79,061
---------
Finance Receivables, net of unearned income of $12,283.... $110,420
=========
The following table presents the contractual maturities of Finance Receivables,
net of unearned income, as of December 31, 2002:
AMOUNT %
--------- ---------
(DOLLARS IN THOUSANDS)
Due within one year ...................... $ 27,384 24.8%
Due within two years ..................... 50,683 45.9%
Due within three years ................... 28,047 25.4%
Due after three years .................... 4,306 3.9%
--------- ---------
Total ................................ $110,420 100.0%
========= =========
The following table presents a summary of the activity for the allowance for
credit losses, for the year ended December 31, 2002:
DECEMBER 31,
2002
----
(IN THOUSANDS)
Balance at beginning of period .................................. $ --
Addition to allowance for credit losses due to acquisition of MFN 59,261
Provision for credit losses ..................................... 2,639
Net charge offs ................................................. (35,732)
Net amount transferred from reserve for repossessed assets ...... (340)
---------
Balance at end of period ........................................ $ 25,828
=========
F-20
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(5) RESIDUAL INTEREST IN SECURITIZATIONS
The following table presents the components of the residual interest in
securitizations:

The following table presents the estimated remaining undiscounted credit losses
included in the fair value estimate of the Residuals as a percentage of the
Company's servicing portfolio subject to recourse provisions:

The key economic assumptions used in measuring retained interest at the date of
securitization during the year ended December 31, 2002, were as follows:
Prepayment speed (Cumulative)....................... 19.8% - 22.9%
Weighted average life (in years).................... 3.2 - 5.0
Expected credit losses (Cumulative)................. 10.0% - 15.4%
Residual cash flows discounted at (per annum)....... 14.0%
Static pool losses are calculated by summing the actual and projected future
credit losses and dividing them by the original balance of each pool of assets.
Static pool losses used to measure the retained interest for each subsequent
year ranged from 10.0% to 15.4% and 12.0% to 17.5% at December 31, 2002 and
2001, respectively.
The key economic assumptions used in measuring all retained interests remaining
as of December 31, 2002 and 2001 are included in the table below. The discount
rate remained constant at 14%.
2002 2001
------------- -------------
Prepayment speed (Cumulative)........... 19.8% - 22.9% 22.0% - 27.2%
Credit losses (Cumulative).............. 10.0% - 15.4% 12.0% - 17.5%
F-21
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Key economic assumptions and the sensitivity of the current fair value of
residual cash flows to immediate 10% and 20% adverse changes in those
assumptions are as follows:

These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on 10% and 20% percent variation
in assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market rates may result in lower prepayments and
increased credit losses), which could magnify or counteract the sensitivities.
The following table summarizes the cash flows received from (paid to)
securitization Trusts:

F-22
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(6) FURNITURE AND EQUIPMENT
The following table presents the components of furniture and equipment:
DECEMBER 31,
-----------------------
2002 2001
-------- --------
(IN THOUSANDS)
Furniture and fixtures ........................... $ 2,994 $ 2,999
Computer equipment ............................... 3,980 3,720
Leasing assets ................................... 729 729
Leasehold improvements ........................... 637 637
Other fixed assets ............................... 17 17
-------- --------
8,357 8,102
Less accumulated depreciation and amortization ... (6,745) (5,756)
-------- --------
$ 1,612 $ 2,346
======== ========
Depreciation expense totaled $1.0 million, $1.0 million and $1.1 million for the
years ended December 31, 2002, 2001 and 2000, respectively.
(7) NOTES PAYABLE TO SECURITIZATION TRUST
On June 28, 2001, MFN issued $301 million of notes secured by automobile sales
finance Contracts (the "Securitized Notes") in a private placement (the "Secured
Financing Agreement"). The issuance was completed through the MFN Auto
Receivables Trust 2001-A of MFN Securitization LLC, a wholly owned subsidiary of
Mercury Finance Company LLC. MFN Securitization LLC is a special purpose company
that holds certain automobile sales finance Contracts of the Company and
borrowed funds under the Secured Financing Agreement. MFN Securitization LLC
paid the borrowed funds to Mercury Finance Company LLC in consideration for the
transfer of certain automobile sales finance Contracts. Both classes of the
Securitized Notes issued under the Secured Financing Agreement bear a fixed rate
of interest until their final distribution. While MFN Securitization LLC is
included in the Company's Consolidated Financial Statements, it is a separate
legal entity. The automobile sales finance Contracts and other assets held by
MFN Securitization LLC are legally owned by MFN Securitization LLC and are not
available to creditors of the Company or its subsidiaries. Interest payments on
the Securitized Notes are payable monthly, in arrears, based on the respective
notes' interest rates. The following table presents the Company's Securitized
Notes outstanding and their stated interest rates at December 31, 2002 (dollars
in thousands):

(1) Payment in full of the Securitized Notes could occur earlier than the final
scheduled distribution date.
Interest expense on the Securitized Notes is composed of the stated rate of
interest plus additional costs of borrowing. Additional costs of borrowing
include facility fees, insurance and amortization of deferred financing costs.
Deferred financing costs related to the Securitized Notes are amortized in
proportion to the principal distributed to the noteholders. Accordingly, the
effective cost of borrowing of the Securitized Notes is greater than the stated
rate of interest.
The Securitized Notes contain various covenants requiring certain minimum
financial ratios and results. The Company was in compliance with these covenants
as of the date of this report. The Securitized Notes also require certain funds
be held in restricted cash accounts to provide additional collateral for the
borrowings or to be applied to make payments on the Securitized Notes. As of
December 31, 2002, restricted cash under the MFN 2001-A Securitization totaled
approximately $11.9 million.
F-23
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(8) DEBT
On December 20, 1995, the Company issued $20.0 million in rising interest
subordinated redeemable securities due January 1, 2006 (the "Notes"). The Notes
are unsecured general obligations of the Company. Interest on the Notes is
payable on the first day of each month, commencing February 1, 1996, at an
interest rate of 10.0% per annum. The interest rate increases 0.25% on each
January 1 for the first nine years and 0.50% in the last year. In connection
with the issuance of the Notes, the Company incurred and capitalized issuance
costs of $1.1 million. The Notes are subordinated to certain existing and future
indebtedness of the Company as defined in the indenture agreement. The Company
is required to redeem on an annual basis, subject to certain adjustments, $1.0
million of the aggregate principal amount of the Notes through the operation of
a sinking fund on or before of January 1, 2000, 2001, 2002, 2003, 2004 and 2005.
The Company may at its option elect to redeem the Notes from the registered
holders of the Notes, in whole or in part at 100% of their principal amount,
plus accrued interest to and including the date of redemption. During each of
the years 1999 through 2002, the Company redeemed $1.0 million of principal
amount of the notes in conjunction with the requirements of the related sinking
fund agreement. The balance outstanding of the Notes at December 31, 2002 and
2001, was $16.0 million and $17.0 million, respectively.
On April 15, 1997, the Company issued $20.0 million in subordinated
participating equity notes ("PENs") due April 15, 2004. The PENs are unsecured
general obligations of the Company. Interest on the PENs is payable on the
fifteenth of each month, commencing May 15, 1997, at an interest rate of 10.5%
per annum. In connection with the issuance of the PENs, the Company incurred and
capitalized issuance costs of $1.2 million. The Company recognizes interest and
amortization expense related to the PENs using the effective interest method
over the expected redemption period. The PENs are subordinated to certain
existing and future indebtedness of the Company as defined in the indenture
agreement. The Company may at its option elect to redeem the PENs from the
registered holders, in whole but not in part, at any time on or after April 15,
2000, at 100% of their principal amount, subject to limited conversion rights,
plus accrued interest to and including the date of redemption. At maturity, upon
the exercise by the Company of an optional redemption, or upon the occurrence of
a "Special Redemption Event," each holder will have the right to convert into
common stock of the Company ("Common Stock"), 25% of the aggregate principal
amount of the PENs held by such holder at the conversion price of $10.15 per
share of Common Stock. "Special Redemption Events" are certain events related to
a change in control of the Company.
In November 1998, the Company issued $25.0 million of subordinated promissory
notes due November 30, 2003, to an affiliate of Levine Leichtman Capital
Partners, Inc., Levine Leichtman Capital Partners II, L.P. ("LLCP"), and
received the proceeds (net of $1.3 million of capitalized issuance costs), of
approximately $23.7 million. The Company also issued warrants to purchase up to
3,450,000 shares of common stock at $3.00 per share, exercisable through
November 30, 2005 (See Note 13). The debt bears interest at 13.5% per annum, and
may not be prepaid without penalty prior to November 1, 2002. Simultaneously
with the consummation of that transaction, certain affiliates of the Company,
who had lent the Company an aggregate of $5.0 million on a short-term basis in
August and September 1998, agreed to subordinate their indebtedness to the
indebtedness in favor of LLCP, to extend the maturity of their debt until June
2004, and to reduce their interest rate from 15% to 12.5%. Such affiliates
received in return the option to convert such debt into an aggregate of
1,666,667 shares of common stock at the rate of $3.00 per share through maturity
at June 30, 2004. Additionally, SFSC also agreed to subordinate $6.0 million, or
40%, of its related party loan in favor of LLCP (See Note 13.).
F-24
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In April 1999, the Company issued an additional $5.0 million of subordinated
promissory notes due April 30, 2004, to the same affiliate of LLCP as noted
above, and received proceeds (net of $312,000 of capitalized issuance costs) of
$4.7 million. The Company also issued warrants to purchase 1,335,000 shares of
the Company's common stock at $0.01 per share to LLCP, exercisable through April
2009. The debt bears interest at 14.5% per annum, and may be prepaid without
penalty at anytime. As part of the purchase agreement, the interest rate on the
previously issued LLCP notes was increased to 14.5% per annum, and the warrant
to purchase 3,450,000 shares of the Company's common stock at $3.00 per share
was exchanged for a warrant to purchase 3,115,000 shares at a price of $0.01 per
share.
In March 2000, the Company issued $16.0 million of senior secured debt to LLCP
("Term B"). The proceeds from the issuance were used to repay in full all
amounts owed under the Senior Secured Line. As part of the agreement, all of
LLCP's existing debt of $30.0 million was restructured as senior secured debt,
making the Company's aggregate principal indebtedness to LLCP equal to $46.0
million. The $16.0 million bears interest at 12.5% per annum and the interest
rate on the $30.0 million is unchanged at 14.5% per annum. As part of the
agreement, all prior defaults were either waived or cured. As of December 31,
2000, the amount outstanding of the $16.0 million portion of senior secured debt
was $8.0 million. The outstanding balance on the $16.0 million LLCP debt was
repaid during the first quarter of 2001. In addition, during the first quarter
of 2001, the Company made a $4.0 million principal prepayment on the remaining
outstanding LLCP debt, incurring $200,000 in prepayment penalties and waiver
fees. The outstanding balance of Term B debt at December 31, 2002 was $21.8
million.
In March 2002, the Company and LLCP entered into an additional series of
agreements under which LLCP provided additional funding to enable the Company to
acquire MFN Financial Corporation. Under the March 2002 agreements, the Company
borrowed $35 million from LLCP as a Bridge Note (Bridge Note) and approximately
$8.5 million ("Term C") on a deemed principal amount of approximately $11.2
million. The Bridge Note requires principal payments of $2.0 million a month,
which began in June 2002, with a final balloon payment in the amount of $17.0
million, which was made pursuant to the terms of the Bridge Note in February
2003. The Term C Note repayment schedule is based on the performance of a
certain securitized pool. As the subordinated Note of the pool is repaid from
the Trust, principal payments are due on the Term C Note. The maturity date of
the Term C Note is March 2008. Interest is due monthly on the Bridge Note at a
rate of 13.5% per annum and on the Term C Note at a rate of 12.0% per annum. In
connection with the March 2002 agreements and the acquisition of MFN, the
Company paid LLCP a structuring fee of $1.75 million and an investment banking
fee of $1.0 million, and paid LLCP's out-of-pocket expenses of approximately
$315,000. In addition, the Company paid LLCP certain other fees and interest
amounting to $426,181. Approximately $1.4 million of the fees and other amounts
paid to LLCP were deferred as financing costs and are being amortized over the
life of the related debt. The remaining fees and other costs were included in
the purchase price of MFN. At December 31, 2002, there was $21.0 million and
$7.3 million principal outstanding on the Bridge Note and Term C, respectively.
During the year ended December 31, 1997 the Company acquired CPS Leasing, Inc.
At December 31, 2002 and 2001, CPS Leasing, Inc., had borrowings to banks of
$673,000 and $1.6 million, respectively.
At the time of the Merger, MFN had outstanding $22.5 million in principal amount
of senior subordinated debt, which was due and repaid in full on March 23, 2002.
Such debt bore interest at the rate of 11.00% per annum, payable quarterly in
arrears.
With respect to all borrowings listed above, the Company was in compliance with
all related financial covenants as of December 31, 2002. Such covenants relate
primarily to financial reporting requirements, restricted payments and certain
ratios as defined in the various debt agreements.
F-25
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table summarizes the amount of senior secured, subordinated and
related party debt maturing over the next 5 years and thereafter as of December
31, 2002:
PRINCIPAL
AMOUNT
---------
(IN THOUSANDS)
2003 ................................................ $ 43,810
2004 ................................................ 38,500
2005 ................................................ --
2006 ................................................ 14,000
2007 ................................................ --
Thereafter .......................................... 7,262
---------
Total ........................................ $103,572
=========
(9) SHAREHOLDERS' EQUITY
COMMON STOCK
Holders of common stock are entitled to such dividends as the Company's Board of
Directors, in its discretion, may declare out of funds available, subject to the
terms of any outstanding shares of preferred stock and other restrictions. In
the event of liquidation of the Company, holders of common stock are entitled to
receive, pro rata, all of the assets of the Company available for distribution,
after payment of any liquidation preference to the holders of outstanding shares
of preferred stock. Holders of the shares of common stock have no conversion or
preemptive or other subscription rights and there are no redemption or sinking
fund provisions applicable to the common stock.
The Company is required to comply with various operating and financial covenants
defined in the agreements governing the warehouse lines, senior debt,
subordinated debt, and related party debt. The covenants restrict the payment of
certain distributions, including dividends (See Note 8.).
Included in common stock at December 31, 2002 and 2001, is additional paid in
capital related to the valuation of certain stock options as required by
Financial Interpretation No. 44 ("FIN 44"). Based on the adoption of FIN 44,
common stock increased by $1,177,000 at December 31, 2002, of which $1,196,000
relates to the effect of options and $(19,000) relates to deferred compensation.
In 2001, common stock decreased by $77,000, of which $280,000 relates to the
effect of options and $(357,000) relates to deferred compensation.
STOCK PURCHASES
During 2000, the Company's Board of Directors authorized the Company to purchase
up to $5 million of Company securities. In October 2002, the Board of Directors
authorized the purchase of an additional $5 million of outstanding debt or
equity securities. As of December 31, 2002, the Company had purchased $3.0
million in principal amount of the notes, and $2.6 million of its common stock,
representing 1,592,611 shares.
OPTIONS AND WARRANTS
In 1991, the Company adopted and its sole shareholder approved the 1991 Stock
Option Plan (the "1991 Plan") pursuant to which the Company's Board of Directors
may grant stock options to officers and key employees. The Plan, as amended,
authorizes grants of options to purchase up to 2,700,000 shares of authorized
but unissued common stock. Stock options are granted with an exercise price
equal to the stock's fair market value at the date of grant. Stock options have
F-26
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
terms that range from 7 to 10 years and vest over a range of 0 to 7 years. In
addition to the 1991 Plan, in fiscal 1995, the Company granted 60,000 options to
certain directors of the Company that vest over three years and expire nine
years from the grant date. The Plan terminated in December 2001, without
affecting the validity of the outstanding options.
In July 1997, the Company adopted and its shareholders approved the 1997
Long-Term Incentive Plan (the "1997 Plan") pursuant to which the Company's Board
of Directors may grant stock options, restricted stock and stock appreciation
rights to employees, directors or employees of entities in which the Company has
a controlling or significant equity interest. Options that have been granted
under the 1997 Plan have in all cases been granted at an exercise price equal to
the stock's fair market value at the date of the grant, with terms of 10 years
and vesting over 5 years. In 2001, the shareholders of the Company approved an
amendment to the 1997 Plan providing that an aggregate maximum of 3,400,000
shares of the Company's common shares may be subject to awards under the 1997
Plan.
In October 1998, the Company's Board of Directors approved a plan to cancel and
reissue certain stock options previously granted to key employees of the
Company. All options granted prior to October 22, 1998, with an option price
greater than $3.25 per share, were repriced to $3.25 per share. In conjunction
with the repricing, a one-year period of non-exercisability was placed on all
repriced options, which period ended on October 21, 1999.
In October 1999, the Company's Board of Directors approved a plan to cancel and
reissue certain stock options previously granted to key employees of the
Company. All options granted prior to October 29, 1999, with an option price
greater than $0.625 per share, were repriced to $0.625 per share. In conjunction
with the repricing, a six-month period of non-exercisability was placed on all
repriced options, which period ended on April 29, 2000.
At December 31, 2002, there were a total of zero additional shares available for
grant under the 1997 Plan, as described below. Of the options outstanding at
December 31, 2002, 2001 and 2000, 920,101, 1,715,767, and 1,532,590,
respectively, were then exercisable, with weighted-average exercise prices of
$1.30, $0.84, and $0.63, respectively.
Stock option activity during the periods indicated is as follows:
NUMBER OF WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
------ --------------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
Balance at December 31, 1999 3,022 $ 0.64
Granted................................. 833 1.70
Exercised............................... 53 0.63
Canceled................................ 298 1.02
---------- ------------
Balance at December 31, 2000 3,504 0.86
Granted................................. 1,069 2.55
Exercised............................... 501 0.63
Canceled................................ 275 1.05
---------- ------------
Balance at December 31, 2001 3,797 1.35
Granted................................. 1,798 1.55
Exercised............................... 1,255 0.64
Canceled................................ 313 1.64
---------- ------------
Balance at December 31, 2002 4,027 $ 1.64
========== ============
F-27
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
During 2002, the Company's Board or Directors approved a program, whereby
officers of the Company would be advanced amounts sufficient to enable them to
exercise certain of their outstanding options. See Note 13.
At December 31, 2002, the range of exercise prices, the number, weighted-average
exercise price and weighted-average remaining term of options outstanding and
the number and weighted-average price of options currently exercisable are as
follows:

Included in the number of options outstanding above are 1,589,200 options the
Company has conditionally granted, subject to shareholder approval in 2003 of an
increase in the number of shares available for grant under its 1997 Long-Term
Incentive Plan, at an exercise price of $1.50. Until and unless such shareholder
approval is gained, these options are not outstanding or exercisable. Excluding
such options, there would be 620,851 options available for grant.
On November 17, 1998, in conjunction with the issuance of a $25.0 million
subordinated promissory note to an affiliate of LLCP, the Company issued
warrants to purchase up to 3,450,000 shares of common stock at $3.00 per share,
exercisable through November 30, 2005. In April 1999, in conjunction with the
issuance of $5.0 million of an additional subordinated promissory note to an
affiliate of LLCP, the Company issued additional warrants to purchase 1,335,000
shares of the Company's common stock at $0.01 per share to LLCP. As part of the
purchase agreement, the existing warrants to purchase 3,450,000 shares at $3.00
per share were exchanged for warrants to purchase 3,115,000 shares at a price of
$0.01 per share. The aggregate value of the warrants, $12.9 million, which is
comprised of $3.0 million from the original warrants issued in November 1998 and
$9.9 million from the repricing and additional warrants issued in April 1999, is
reported as deferred interest expense to be amortized over the expected life of
the related debt, five years. As of December 31, 2002, 1,000 warrants remained
unexercised. Such warrants, and the 4,449,000 shares of common stock have upon
the exercise of such warrants not been registered for public sale. However, the
holder has the right to require the Company register the warrants and common
stock for public sale in the future.
Also in November 1998, the Company entered into an agreement with the Note
Insurer of its asset-backed securities. The agreement committed the Note Insurer
to provide insurance for the securitization of $560.0 million in asset-backed
securities, of which $250.0 million remained at December 31, 1998. The agreement
provides for a 3% initial Spread Account deposit. As consideration for the
agreement, the Company issued warrants to purchase up to 2,525,114 shares of
common stock at $3.00 per share, subject to anti-dilution adjustments. The
warrants are fully exercisable on the date of grant and expire in November 2003.
The value of the warrants, $2.2 million, is included in other assets as deferred
securitization expense to be amortized over five years. As of December 31, 2002,
the warrants had not been registered for public sale. However, the holder of the
warrants has the right to require the Company to register the warrants for
public sale in the future.
F-28
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(10) GAIN (LOSS) ON SALE OF CONTRACTS
The following table presents the components of the net gain (loss) on sale of
Contracts:

The tax effected cumulative temporary differences that give rise to deferred tax
assets and liabilities as of December 31, 2002 and 2001, are as follows:
DECEMBER 31,
--------------------------
2002 2001
--------- ---------
(IN THOUSANDS)
Deferred Tax Assets:
Accrued liabilities .......................... $ 2,760 $ 1,030
Furniture and equipment ...................... 2,335 --
Equity investment ............................ 82 751
NOL carryforward ............................. 36,979 16,522
Minimum tax credit ........................... 334 334
Provision for loan loss ...................... 1,383 --
Pension Accrual .............................. 1,063 --
Other ........................................ 110 115
--------- ---------
Total deferred tax assets ................ 45,046 18,752
Valuation allowance .......................... (8,563) (3,219)
--------- ---------
36,483 15,533
Deferred Tax Liabilities:
NIRs ......................................... (13,568) (8,036)
Debt Forgiveness ............................. (29,629) --
Furniture and equipment ...................... -- (68)
--------- ---------
Total deferred tax liabilities ........... (43,197) (8,104)
--------- ---------
Net deferred tax asset (liability) ....... $ (6,714) $ 7,429
========= =========
As part of the purchase of MFN Financial Corporation and its subsidiaries (MFN),
CPS acquired certain net operating losses, debt forgiveness, as discussed below,
and built in loss assets. Moreover, MFN has undergone an ownership change for
purposes of Internal Revenue Code ("IRC") section 382. In general, IRC section
382 imposes an annual limitation on the ability of a loss corporation (i.e., a
corporation with a net operating loss ("NOL") carryforward, credit carryforward,
or certain built-in losses ("BILs")) to utilize its pre-change NOL carryforwards
or BILs to offset taxable income arising after an ownership change. During 1999,
MFN recorded an extraordinary gain from the discharge of indebtedness related to
the emergence from Bankruptcy. This gain was not taxable under IRC section 108.
In accordance with the rules under IRC section 108, MFN has reduced certain tax
attributes including unused net operating losses and tax basis in certain MFN
assets. Deferred taxes have been provided for the estimated tax effect of the
future reversing timing differences related to the discharge of indebtedness
gain as reduced by the tax attributes. Additionally, the Company has established
a valuation allowance of $8.6 million against MFN's deferred tax assets, as it
is not more than likely that these amounts will be realized in the future. In
F-30
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
determining the possible future realization of deferred tax assets, future
taxable income from the following sources are taken into account: (a) reversal
of taxable temporary differences, (b) future operations exclusive of reversing
temporary differences, and (c) tax planning strategies that, if necessary, would
be implemented to accelerate taxable income into years in which net operating
losses might otherwise expire.
As of December 31, 2002, the Company has net operating loss carryforwards for
federal and state income tax purposes of $52 million and $59 million,
respectively, which are available to offset future taxable income, if any,
subject to IRC section 382 limitations, through 2021 and 2011, respectively. In
addition, the Company has an alternative minimum tax credit carryforward of
approximately $334,000, which is available to reduce future federal regular
income taxes, if any, over an indefinite period.
The Company's tax returns are open for audits by various tax authorities.
Therefore, from time-to-time there may be differences in opinions with respect
to the tax treatment accorded to certain transactions. When, and if, such
differences occur and become probable and estimatable, such amounts will be
recognized. The Company has historically filed its tax returns on a fiscal year
ending March 31, but expects to change its tax fiscal year to a calendar year
effective December 31, 2002.
(13) RELATED PARTY TRANSACTIONS
INVESTMENT IN UNCONSOLIDATED AFFILIATES
The Company purchased a 38% interest in NAB Asset Corporation ("NAB") on June 6,
1996, for approximately $4.3 million. At the time of the acquisition, NAB had
approximately $3.5 million in cash and no significant operations. The Company's
purchase price of its investment in NAB exceeded the Company's share of the net
assets of NAB at the acquisition date by approximately $1.4 million. This
amount, which was included in other assets in the accompanying Consolidated
Balance Sheets as goodwill, was being amortized over a period of fifteen years.
During 1999, the Company determined that the value of the goodwill was impaired
and wrote off the remaining balance of the goodwill which is included in other
income (loss) in the accompanying Consolidated Statement of Operations. During
the fourth quarter of 2001, the Company sold its investment in NAB to an
unrelated third party for $204,110 in cash, which is recorded as other income in
the Company's Consolidated Statement of Operations.
Subsequent to the Company's investment in NAB, NAB purchased Mortgage Portfolio
Services, Inc. ("MPS") from the Company for $300,000. MPS, formed by the Company
in April 1996, is a mortgage broker-dealer based in Texas. In July 1996, NAB
formed CARSUSA, Inc. ("CARSUSA"), which purchased, and now owns and operates, a
Mitsubishi automobile dealership in Southern California. On June 27, 1997, NAB
sold CARSUSA to Charles E. Bradley, Sr. and Charles E. Bradley, Jr., for $1.5
million. Included in other income for the year ended December 31, 2000, are
losses of $755,081, which represents the Company's share of NAB's net loss. No
such loss is included for the year ended December 31, 2001, as the Company's
investment is NAB had been written down to zero in 2000.
RELATED PARTY RECEIVABLES
As of December 31, 2001, the Company had amounts receivable from CARSUSA
totaling $669,000. During 2002, the Company determined that such receivable was
uncollectible as a result of the sale of CARSUSA to an unaffiliated party and
the entire receivable amount was written off. The write off of $669,000 related
to the CARSUSA receivable is reflected in the Company's Consolidated Statement
of Operations for the year ended December 31, 2002 in general and administrative
expenses. The Company purchased 7, 16 and 28 Contracts from CARSUSA, with an
aggregate principal balance of approximately $99,996, $233,431 and $414,052,
respectively, in 2002, 2001 and 2000.
F-31
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Stanwich Partners, Inc. is an affiliate of Charles E. Bradley, Sr., former
Chairman of the Board of Directors of the Company. The Company was previously
party to a consulting agreement with Stanwich Partners, Inc. that called for
monthly payments of $6,250 per month. Included in the accompanying Consolidated
Statements of Operations for the year ended December 31, 2000, is $12,500
consulting expense related to this consulting agreement. There was no such
consulting expense paid in 2002 or 2001.
CPS LEASING, INC. RELATED PARTY DIRECT LEASE RECEIVABLES
Included in other assets recorded in the Company's Consolidated Balance Sheet
are direct lease receivables due to CPS Leasing, Inc. from related parties,
primarily companies affiliated with the Company's former Chairman of the Board
of Directors. Such related party direct lease receivables totaled approximately
$2.2 million and $3.1 million at December 31, 2002 and 2001, respectively.
RELATED PARTY DEBT
In June 1997 the Company borrowed $15 million on an unsecured and subordinated
basis from Stanwich Financial Services Corp. ("SFSC"), an affiliate of Charles
E. Bradley, Sr., the former Chairman of the Company's Board of Directors. This
loan ("RPL") is due 2004, and has a fixed rate of interest of 9% per annum,
payable monthly beginning July 1997. The Company may pre-pay the RPL without
penalty at any time after three years. At maturity or repayment of the RPL, the
holder thereof will have an option to convert 20% of the principal amount into
common stock of the Company, at a conversion rate of $11.86 per share. The
balance of the RPL at December 31, 2002 and 2001, was $15.0 million.
During 1998, the Company borrowed an additional $4 million on an unsecured basis
from SFSC. This loan ("RPL2") is due 2004, and has a fixed rate of interest of
12.5% per annum payable monthly beginning December 1998. The Company had the
right to pre-pay the RPL2, without penalty, at any time after June 12, 2000. At
maturity or repayment of the RPL2, the holder thereof would have the option to
convert the entire principal balance of the note, or a portion thereof, into
common stock of the Company, at a conversion rate of $3 per share. The balance
of the RPL2 was repaid during the first quarter of 2001.
During 1998, the Company borrowed $1.0 million on an unsecured basis from John
G. Poole, a director of the Company. The terms of this note ("RPL3") are the
same as the RPL2. The balance of the RPL3 at December 31, 2002 and 2001 was $1.0
million.
During 1999, the Company borrowed $1.5 million on an unsecured basis from SFSC.
This loan ("RPL4") is due 2004, has a fixed rate of interest of 14.5% per annum
payable monthly beginning October 1999. In conjunction with the issuance of the
RPL4, the Company issued warrants to purchase 103,500 shares of the Company's
common stock at a price of $0.01 per share. The balance of the RPL4 at December
31, 2002 and 2001 was $1.5 million.
LOANS TO OFFICERS TO EXERCISE CERTAIN STOCK OPTIONS
During 2002, the Company's Board or Directors approved a program under which
officers of the Company would be advanced amounts sufficient to enable them to
exercise certain of their outstanding options. Such loans were available for a
limited period of time, and available only to exercise previously repriced
options. The loans are collateralized by the common stock acquired through the
exercise of the repriced options, bear interest at a rate of 5.50% per annum,
and are due in 2007. At December 31, 2002, there was $478,531 outstanding
related to these loans. Such amounts have been recorded as contra-equity in the
Shareholders' Equity section of the Company's Consolidated Balance Sheet.
F-32
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(14) COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its facilities and certain computer equipment under
non-cancelable operating and capital leases, which expire through 2008. Future
minimum lease payments at December 31, 2002, under these leases are as follows:
CAPITAL OPERATING
---------- ----------
(IN THOUSANDS)
2003........................................ $ 70 $ 4,317
2004........................................ -- 3,950
2005........................................ -- 3,872
2006........................................ -- 3,322
2007........................................ -- 2,795
Thereafter.................................. -- 1,748
---------- ----------
Total minimum lease payments................ 70 $ 20,004
==========
Less: amount representing interest.......... 3
---------
Present value of net minimum lease payments. $ 67
==========
Included in furniture and equipment in the accompanying Consolidated Balance
Sheet are the following assets held under capital leases at December 31, 2002:
Furniture and fixtures.................................... $ 2,044
Computer equipment........................................ 152
---------
2,196
Less: accumulated depreciation............................ 2,082
---------
$ 114
=========
Rent expense for the years ended December 31, 2002, 2001 and 2000, was $4.0
million, $2.6 million, and $3.2 million, respectively.
The Company's facility lease contains certain rental concessions and escalating
rental payments, which are recognized as adjustments to rental expense and are
amortized on a straight-line basis over the term of the lease.
During 2002, 2001 and 2000, the Company received $140,537, $270,486 and
$968,920, respectively, of sublease income, which is included in occupancy
expense. Future minimum sublease payments totaled $113,805 at December 31, 2002.
LITIGATION
On May 12, 2000, Jon L. Kunert and Penny Kunert commenced a lawsuit against an
automobile dealer, the Company and in excess of 20 other defendants in the
Superior Court of California, Los Angeles County. The defendants other than the
automobile dealer appear to be various entities ("finance defendants") that may
have purchased retail installment contracts from that dealer. The lawsuit
alleges that the various finance defendants conspired with the automobile dealer
defendant to conceal from motor vehicle purchasers the full cost of credit
applicable to their purchases, and seeks a refund of the concealed excess cost.
The court subsequently ordered the plaintiffs to file separate lawsuits against
each finance defendant. Such a substitute lawsuit was filed against the Company
by Angela Hicks, on March 8, 2001. The lawsuits were dismissed with prejudice in
September 2001. The dismissal is currently on appeal.
F-33
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On November 15, 2000, Denice and Gary Lang commenced a lawsuit against the
Company in South Carolina Common Pleas Court, Beaufort County, alleging that
they, and a purported nationwide class, were harmed by an alleged failure to
refer, in the notice given after repossession of their vehicle, of the right to
purchase the vehicle by tender of the full amount owed under the retail
installment contract. They seek damages in an unspecified amount.
On July 23, 1997, Elaine McLean commenced a lawsuit in the 134th District Court,
Dallas County, Texas against a subsidiary of MFN in the state of Texas alleging
deceptive practices related to various loans and the related purchase and sale
of insurance. The lawsuit seeks damages in an unspecified amount.
In 2001, the district court denied McLean's motion for class certification.
Later that same year, the appellate court denied McLean's appeal of the district
court ruling. The appellate court's denial is itself currently on appeal.
STANWICH LITIGATION. The Company is currently a defendant in a class action (the
"Stanwich Case") pending in the California Superior Court, Los Angeles County.
The plaintiffs in that case are persons entitled to receive regular payments
(the "Settlement Payments") under out-of-court settlements reached with third
party defendants. Stanwich Financial Services Corp. ("Stanwich"), an affiliate
of the former Chairman of the Board of Directors of the Company, is the entity
that is obligated to pay the Settlement Payments. Stanwich has defaulted on its
payment obligations to the plaintiffs and in June 2001 filed for reorganization
under the Bankruptcy Code, in the federal Bankruptcy Court of Connecticut. The
Company is also a defendant in certain cross-claims brought by other defendants
in the case, which assert claims of equitable and/or contractual indemnity
against the Company.
In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee,
asserted claims for indemnity against the Company in a separate action, which is
now pending in federal district court in Rhode Island. The Company has filed
counterclaims in the Rhode Island federal court against Mr. Pardee. The Company
plans to defend this matter and pursue its counterclaims vigorously.
In February 2002, the Company entered into a Term Sheet with Stanwich, the
plaintiffs in the Stanwich Case and others, which provides for the Company's
release upon its repayment of the amounts concededly owed to Stanwich, all of
which amounts have been recorded in the Company's financial statements as
indebtedness.
In February 2003, a court-sponsored mediation resulted in an agreement in
principle to settle the Stanwich Case (other than with respect to defendant
Pardee). The Company believes that the plaintiff's allegations and the
cross-claims brought by other defendants referenced above will be dismissed upon
final execution of such settlement.
MISSISSIPPI LITIGATION. On September 26, 2001, Maggie Chandler, Bobbie Mike and
Mary Ann Benford each commenced a lawsuit against subsidiaries of MFN in the
state of Mississippi. Chandler filed in Mississippi state court, county of
Leflore. Mike filed in Mississippi state court, county of Humphreys. Benford
filed in Mississippi state court, county of Holmes. Plaintiffs in all three
cases allege deceptive practices related to various loans and the related
purchase and sale of insurance, and seek unspecified damages. The Company
believes that there are substantive legal defenses to such claims, and intends
to defend them vigorously.
F-34
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The outcome of any litigation is uncertain, and there is the possibility that
damages could be awarded against the Company in amounts that could be material.
It is management's opinion, based on the advice of counsel, that all litigation
of which it is aware, including the matters discussed above, will not have a
material adverse effect on the Company's consolidated financial position,
results of operations or liquidity, beyond reserves already taken.
(15) EMPLOYEE BENEFITS
The Company sponsors a pretax savings and profit sharing plan (the "401(k)
Plan") qualified under section 401(k) of the Internal Revenue Code. Under the
401(k) Plan, eligible employees are able to contribute up to 15% of their
compensation (subject to stricter limitation in the case of highly compensated
employees). The Company, may, at its discretion, match 100% of employees'
contributions up to $1,000 per employee per calendar year. The Company's
contributions to the 401(k) Plan was $213,045 for the year ended December 31,
2000. The Company did not make a matching contribution in 2002 or 2001, other
than to employees eligible for the MFN Financial Corporation Retirement Savings
Plan. Such contribution amounted to $250,682 for the period from the Merger Date
through December 31, 2002. The MFN Financial Corporation Retirement Savings Plan
was merged into the Company's 401(k) Plan in February 2003.
The Company also sponsors the MFN Financial Corporation Pension Plan ("the
Plan"). The Plan benefits were frozen June 30, 2001. The following table sets
forth the funded status of the Plan and amounts recognized in the 2002
Consolidated Financial Statements.
F-35
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31,
2002
----
(DOLLARS IN
THOUSANDS)
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation, beginning of year .................. $ 12,223
Service cost ..................................................... --
Interest cost .................................................... 853
Settlements ...................................................... (826)
Actuarial gain ................................................... 2,964
Benefits paid .................................................... (1,471)
---------
Projected benefit obligation, end of year ..................... $ 13,743
=========
CHANGE IN PLAN ASSETS
Fair value of plan assets, beginning of year ..................... $ 12,013
Return on assets ................................................. (636)
Employer contribution ............................................ --
Benefits paid .................................................... (1,471)
---------
Fair value of plan assets, end of year ........................ $ 9,906
=========
Plan assets were held primarily in cash at December 31, 2002.
RECONCILIATION OF ACCRUED PENSION COST AND TOTAL AMOUNT RECOGNIZED
Funded status of the plan ........................................ $ (3,836)
Unrecognized loss ................................................ 2,771
Unrecognized transition asset .................................... (115)
Unrecognized prior service cost .................................. --
---------
Accrued pension cost .......................................... $ (1,180)
=========
WEIGHTED AVERAGE ASSUMPTIONS AS OF DECEMBER 31, 2002
Discount rate .................................................... 6.50%
Expected return on plan assets ................................... 9.00%
Rate of compensation increase .................................... N/A
AMOUNTS RECOGNIZED IN CONSOLIDATED BALANCE SHEET
Prepaid benefit cost ............................................. $ --
Accrued minimum pension obligation ............................... (3,836)
Intangible asset ................................................. --
Accumulated other comprehensive income, pretax ................... 2,656
---------
Net amount recognized ......................................... $ (1,180)
=========
TOTAL COST
Service cost ..................................................... $ --
Interest cost .................................................... 853
Expected return on assets ........................................ (1,052)
Amortization of unrecognized loss ................................ --
Amortization of transition obligation ............................ (25)
Amortization of prior service cost ............................... --
---------
Net periodic pension income ...................................... (224)
Loss due to settlement ........................................... 224
---------
Total benefit income .......................................... $ --
=========
F-36
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following summary presents a description of the methodologies and
assumptions used to estimate the fair value of the Company's financial
instruments. Much of the information used to determine fair value is highly
subjective. When applicable, readily available market information has been
utilized. However, for a significant portion of the Company's financial
instruments, active markets do not exist. Therefore, considerable judgments were
required in estimating fair value for certain items. The subjective factors
include, among other things, the estimated timing and amount of cash flows, risk
characteristics, credit quality and interest rates, all of which are subject to
change. Since the fair value is estimated as of December 31, 2002 and 2001, the
amounts that will actually be realized or paid at settlement or maturity of the
instruments could be significantly different. The estimated fair values of
financial assets and liabilities at December 31, 2002 and 2001, were as follows:

CASH AND RESTRICTED CASH
The carrying value equals fair value.
FINANCE RECEIVABLES, NET
The carrying value approximates fair value because the related interest rates
are estimated to reflect current market conditions for similar types of
instruments.
RESIDUAL INTEREST IN SECURITIZATIONS
The fair value is estimated by discounting future cash flows using credit and
discount rates that the Company believes reflect the estimated credit, interest
rate and prepayment risks associated with similar types of instruments.
RELATED PARTY RECEIVABLES
The carrying value approximates fair value because the related interest rates
are estimated to reflect current conditions for similar types of investments.
F-37
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
COMMITMENTS
The fair value of commitments to purchase contracts from Dealers is determined
by purchase commitments from investors and prevailing market rates.
NOTES PAYABLE, SECURITIZATION TRUST DEBT AND SENIOR SECURED DEBT
The carrying value approximates fair value because the related interest rates
are estimated to reflect current market conditions for similar types of secured
instruments.
SUBORDINATED DEBT
The fair value is based on average trading activity occurring in the last 5 days
of the respective periods.
RELATED PARTY DEBT
The fair value is based on the fair value of subordinated debt, as the terms and
structure are similar.
(17) LIQUIDITY
The Company's business requires substantial cash to support its purchases of
Contracts and other operating activities. The Company's primary sources of cash
have been cash flows from operating activities, including proceeds from sales of
Contracts, amounts borrowed under various revolving credit facilities (also
sometimes known as warehouse credit facilities), servicing fees on portfolios of
Contracts previously sold, customer payments of principal and interest on
Contracts held for sale, fees for origination of Contracts, and releases of cash
from credit enhancements provided by the Company for the financial guaranty
insurers (Note Insurers) and Investors, initially made in the form of a cash
deposit to an account (Spread Account), and releases of cash from securitized
pools of Contracts in which the Company has retained a residual ownership
interest. The Company's primary uses of cash have been the purchases of
Contracts, repayment of amounts borrowed under lines of credit and otherwise,
operating expenses such as employee, interest, occupancy expenses and other
general and administrative expenses, the establishment of and further
contributions to "Spread Accounts" (cash posted to enhance credit of securitized
pools), and income taxes. There can be no assurance that internally generated
cash will be sufficient to meet the Company's cash demands. The sufficiency of
internally generated cash will depend on the performance of securitized pools
(which determines the level of releases from Spread Accounts), the rate of
expansion or contraction in the Company's servicing portfolio, and the terms
upon which the Company is able to acquire, sell, and borrow against Contracts.
During the years ended December 31, 2002 and 2001, the Company purchased
Contracts for resale into securitization transactions. The Company did not sell
Contracts in a securitization transaction during 2000 or 1999; however, since
November 2000, the Company has been able to purchase Contracts for its own
account, which are generally resold into a term securitization transaction,
using proceeds from two warehouse lines of credit. These warehouse lines of
credit consist of a $125 million floating rate variable funding note facility,
and a $75 million floating rate variable funding note facility. These facilities
are independent of each other, and are funded and insured by different
institutions. Approximately 73.0% and 72.5%, respectively, of the principal
balance of Contracts may be advanced to the Company under these facilities,
subject to collateral tests and certain other conditions and covenants.
The Company's ability to adjust the quantity of Contracts that it purchases and
sells will be subject to general competitive conditions and the continued
availability of the floating rate variable note purchase facilities. There can
be no assurance that the desired level of Contract acquisition can be maintained
F-38
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
or increased. Obtaining releases of cash from the Spread Accounts is dependent
on collections from the related Trusts generating sufficient cash to maintain
the Spread Accounts in excess of the amended specified levels. There can be no
assurance that collections from the related Trusts will generate cash in excess
of the amended specified levels.
Certain of the Company's securitization transactions and the CPS Warehouse Trust
floating rate floating rate variable note purchase facility contain various
covenants requiring certain minimum financial ratios and results. The Company
was in compliance with these covenants as of the date of this report.
(18) SUBSEQUENT EVENTS
The Company purchased 321,944 shares of its common stock from a former director
pursuant to its Board of Directors authorized purchase plan on January 13, 2003
for a total cost of $643,888.
On February 3, 2003, the Company and LLCP entered into an additional series of
agreements under which LLCP provided additional funding to the Company. Under
the February 2003 agreements, the Company borrowed $25 million from LLCP, net of
fees and expenses of $1.05 million, ("Term D"). Term D is due in April 2003,
which may be extended to May 2003 with the payment of a $125,000 extension fee,
and further extended to January 2004 with the payment of an additional $125,000
fee. Term D is bears interest monthly at rates ranging from 4.0% to 12.0 %,
depending on the ultimate term of the note.
In a separate transaction, the Company repaid the Bridge Note on February 21,
2003. See Note 8.
The CPS Warehouse Trust warehouse line of $125 million originally established in
March 2002, was renewed and restated on March 6, 2003. Approximately 73% of the
principal balance of Contracts may be advanced to the Company under this
facility.
F-39
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(1) Diluted extraordinary item per share and net income per share
information of $0.80 and $0.76, previously reported in the Company's
Form 10-Q filing for the quarterly period ended March 31, 2002, differs
from the amounts shown above because the Company previously calculated
such amounts incorrectly, by inappropriately including in its
calculation 2,373,000 incremental shares attributable to options,
warrants and convertible debt in the denominator used in the
calculation of the per share information.
Additionally, the extraordinary item per share and net income per share
information of $0.79 and $0.78 for the six-month period ended June 30,
2002, and $0.80 and $0.85 for the nine-month period ended September 30,
2002, incorrectly included 2,584,000 and 1,192,000 incremental shares,
respectively, attributable to options, warrants and convertible debt in
the denominator used in the calculation of the per share information.
The correct extraordinary item per share and net income per share
information for the six-month period ended June 30, 2002 was $0.90 and
$0.88, and $0.83 and $0.88 for the nine-month period ended September
30, 2002.
F-40
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Agreement and Plan of Merger, dated as of November 18, 2001,
by and among the Registrant, CPS Mergersub, Inc. and MFN
Financial Corporation. (Form 8-K filed on November 19, 2001 by
MFN Financial Corporation).
3.1 Restated Articles of Incorporation (Form 10-KSB dated December
31, 1995)
3.2 Amended and Restated Bylaws (Form 10-K dated December 31,
1997)
4.1 Indenture re Rising Interest Subordinated Redeemable
Securities ("RISRS") (Form 8-K filed December 26, 1995)
4.2 First Supplemental Indenture re RISRS (Form 8-K filed December
26, 1995)
4.3 Form of Indenture re 10.50% Participating Equity Notes
("PENs") (Form S-3, no. 333-21289)
4.4 Form of First Supplemental Indenture re PENs (Form S-3, no.
333-21289)
4.5 Second Amended and Restated Securities Purchase Agreement,
dated as of March 8, 2002, by and between Levine Leichtman
Capital Partners II, L.P. and the Registrant. (Form 8-K filed
on March 25, 2002).
4.5a First Amendment to the Second Amended and Restated Securities
Purchase Agreement dated as of March 8, 2002. (Schedule 13D
filed with respect to the Company on February 11, 2003).
4.5b Second Amendment to the Second Amended and Restated Securities
Purchase Agreement dated as of March 8, 2002. (Schedule 13D
filed with respect to the Company on February 11, 2003).
4.6 Secured Senior Note due February 28, 2003 issued by the
Registrant to Levine Leichtman Capital Partners II, L.P. (Form
8-K filed on March 25, 2002).
4.7 Second Amended and Restated Secured Senior Note due November
30, 2003 issued by the Registrant to Levine Leichtman Capital
Partners II, L.P. (Form 8-K filed on March 25, 2002).
4.8 12.00% Secured Senior Note due 2008 issued by the Registrant
to Levine Leichtman Capital Partners II, L.P. (Form 8-K filed
on March 25, 2002).
4.8.1 Secured Senior Note dated February 3, 2003, issued by the
Registrant to Levine Leichtman Capital Partners II, L.P.
(Schedule 13D filed with respect to the Company on February
11, 2003).
4.9 Sale and Servicing Agreement, dated as of March 1, 2002, among
the Registrant, CPS Auto Receivables Trust 2002-A, CPS
Receivables Corp., Systems & Services Technologies, Inc. and
Bank One Trust Company, N.A. (Form 8-K filed on March 25,
2002).
4.10 Indenture, dated as of March 1, 2002, between CPS Auto
Receivables Trust 2002-A and Bank One Trust Company, N.A.
(Form 8-K filed on March 25, 2002).
10.1 1991 Stock Option Plan & forms of Option Agreements thereunder
(Form 10-KSB dated March 31, 1994)
10.2 1997 Long-Term Incentive Stock Plan (Form 10-K dated March
10, 1998)
10.3 Lease Agreement re Chesapeake Collection Facility (Form 10-K
dated December 31, 1996)
10.4 Lease of Headquarters Building (Form 10-Q dated September 30,
1997)
10.5 Partially Convertible Subordinated Note (Form 10-Q dated
September 30, 1997)
10.13 FSA Warrant Agreement dated November 30, 1998 (Form 10-K dated
December 31, 1998)
10.29 Warrant to Purchase 1,335,000 Shares of Common Stock (Schedule
13D filed on April 21, 1999)
10.32 Amendment to Master Spread Account Agreement (Form 10-K dated
December 31, 1999)
23.1 Consent of independent auditors (filed herewith)
EX-23.1
3
cps_10kex23-1.txt
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Consumer Portfolio Services, Inc:
We consent to the incorporation by reference in the registration statement (Nos.
33-77314 and 333-00880) on Form S-3 and the registration statements (Nos.
33-78680, 33-80327, 333-35758 and 333-75594) on Form S-8 of Consumer Portfolio
Services, Inc. of our report dated February 26, 2003, except as to the last
paragraph of note 18, which is as of March 6, 2003, with respect to the
consolidated balance sheets of Consumer Portfolio Services, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the related consolidated
statements of operations, comprehensive income (loss), shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
2002, which report appears in the December 31, 2002, annual report on Form 10-K
of Consumer Portfolio Services, Inc.
/s/ KPMG LLP
- ------------
Orange County, California
March 25, 2003
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